The Pharmaceutical Pricing Compendium

www.pharmaceuticalpricing.com
The Pharmaceutical
Pricing Compendium
A PRACTICAL GUIDE TO THE PRICING AND REIMBURSEMENT OF MEDICINES
• Benefit from expert opinion and
case studies
• Wide range of subjects covered
• Designed for desktop reference

The Pharmaceutical Pricing
Compendium
A practical guide to the pricing and reimbursement of medicines
Published and Distributed by
Urch Publishing Ltd
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PHARMACEUTICAL PRICING COMPENDIUM
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 2003 Urch Publishing Ltd
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© 2003 Urch Publishing Ltdii

TABLE OF CONTENTS
Foreword 1
Chapter 1. The art of pricing in the pharmaceutical industry 5
Mario R. Nacinovich Jr, Fission Communications (US)
The business of pricing
Chapter 2. Global pricing strategies for pharmaceutical product launches 13
Peter J. Rankin, Gregory K. Bell and Tim Wilsdon, Charles River Associates (US)
Chapter 3. Integrating pricing and reimbursement needs into drug
development 25
Cecil Nick, PAREXEL International (UK)
Marketing issues
Chapter 4. Assessing the pharmaceutical price modelling tools 33
Gary Johnson, Inpharmation Ltd (UK)
Chapter 5. Managing price throughout the life cycle of a pharmaceutical
product: tools, timing and strategies 39
Judith D. Bentkover, Marc R. Larochelle and Patricia M. Russell, Innovative
Health Solutions (US)
The effect of health economics
Chapter 6. The importance of health economics in successfully achieving a
sustainable price for reimbursement 49
Paul C. Langley, 3M Pharmaceuticals (US)
Chapter 7. Hospital negotiation – the use of health economics as a support
for new product pricing 61
Brian Lovatt, Vision Healthcare (UK)
Ethical versus economic issues
Chapter 8. The global AIDS crisis and drug pricing controversy 69
Faiz Kermani, Chiltern International (UK)
Regional Issues in pricing and reimbursement
Chapter 9. Trends in international pharmaceutical pricing and
reimbursement 77
Jorge Mestre-Ferrandiz, Office of Health Economics (UK)
Chapter 10. The future of parallel trade in pharmaceuticals in Europe 87
Klaus Hilleke, Simon Kucher & Partners (Germany)
Europe
Chapter 11. Pricing considerations for new products in Europe 95
Roland Pfeiffer, Altana Pharma AG (Germany)
Chapter 12. Schering’s policy for pharmaceutical price harmonisation in
Europe 101
Michael Bohn, Schering AG (Germany)
© 2003 Urch Publishing Ltd iii

US
Chapter 13. Bio-pharmaceutical prices and the effects on the US economy 107
Roger A. Edwards, Haleh Armian-Hawley and Louise Firth, TIAX LLC (US)
National and international law and pharma pricing
Chapter 14. Differential pricing in the EU: significance of the decision in the
GlaxoSmithKline case 121
Lorna Brazell, Bird & Bird (UK)
Chapter 15. Additional information about pharmaceutical pricing and
reimbursement 131
Terminology of pharmaceutical pricing 137
List of Figures
Figure 1.1 The art of pharmaceutical pricing 6
Figure 1.2 The drug development process 7
Figure 2.1 Strategic considerations for global product launch 14
Figure 2.2 Determining optimal global price 15
Figure 2.3 Price bands: no variation 22
Figure 2.4 Price bands: increasing price discrimination 23
Figure 5.1 Spending and time requirements for pharmaceutical R&D by phase 42
Figure 5.2 Floor price analysis for example product 44
Figure 7.1 The measurement of economic costs and benefits in healthcare
research 65
Figure 9.1 Reimbursement and pricing decisions 78
Figure 9.2 The effects of reference pricing systems 81
Figure 10.1 The global price corridor 91
Figure 10.2 Factors influencing the future of parallel trade in Europe 92
Figure 11.1 Market share of parallel imports in Germany 98
Figure 11.2 Average time intervals between submission of the P&R dossier and
the awarding of pricing and reimbursement permission 100
Figure 12.1 Different price levels of pharmaceuticals in Europe (ex-
manufacturer prices, 1998, index based on official exchange rates,
104
Figure 13.1 d percentage of US
thcare
112
Figure 13.5
116
Figure 13.8 echnology sectors
116
Figure 15.1 e total reimbursed
133
Figure 15.2 etween application and award of pricing
134
Figure 15.4
11 134
D = 100) 103
Figure 12.2 The optimal launch sequence
Pharmaceutical expenditures worldwide an
health spending on pharmaceuticals, 1960–2001 109
Figure 13.2 Worldwide private and public R&D funding for heal 110
Figure 13.3 Worldwide genomics research investments, 2000 111
Figure 13.4 Worldwide components of the pricing and innovation puzzle
Biotechnology revenues, drugs on the market and drugs in clinical
trials 113
Figure 13.6 Total economic impact by the pharmaceutical sector, 1999 115
Figure 13.7 Total pharmaceutical industry economic contributions by type, 1999
Market capitalisation of pharmaceutical and biot
as percentages of total market value, 1990–2000
Estimated costs paid by the patient in th
pharmacy market value at retail prices, 2000 (%)
Average time intervals b
and reimbursement (days) 133
Figure 15.3 Average retail prescription prices, 1990–2000
Projected drug spending by and for the Medicare population, 2001–
© 2003 Urch Publishing Ltdiv

CONTENTS
Figure 15.5 Manufacturers’ price increases for existing drugs versus retail
prescription price increases reflecting the use of newer drugs,
1991–2000 135
Figure 15.6 Generic drugs as a percentage of total prescriptions dispensed and
percentage of total annual retail prescription sales, in US dollars,
1996–2000 135
84
Table 10.1 el imports in key European markets in
102
Table 12.2 t in pharmaceuticals. Originator
ons, 2000
ries (list prices)
131
Table 15.3 eutical cost-containment methods used in 18
Table 15.4 Estimated discounts for larger/institutional buyers in the US 136
List of Tables
Table 1.1 Factors influencing a product’s price 8
Table 1.2 Estimates of the average cost of developing a new drug 9
Table 1.3 Influences on pharmaceutical prices 10
Table 4.1 Summary of techniques used to determine market response to a
product’s proposed price 37
Table 5.1 Annualised costs of existing urinary incontinence interventions (€) 41
Table 5.2 Possible costs of new urinary incontinence interventions and
comparison with existing interventions (€) 41
Table 5.3 Pricing research stakeholders and key issues to explore 43
Table 5.4 Potential strategies to respond to changes in the competitive
landscape 46
Table 6.1 Relative market potential for pharmaceutical sales 56
Table 7.1 Definitions of health economics methodology 63
Table 7.2 Health economics methodologies used in the pharmaceutical sector 64
Table 8.1 Summary of pharmaceutical companies’ best ARV price offers for
developing countries (prices in US dollars per adult per year) 73
Table 9.1 Which method to use: price per DDD, per gram or per unit? 82
Table 9.2 Effects of using different exchange rates 83
Table 9.3 Effect of using different weights in pharmaceutical price
comparisons
Market share of parall
selected years, by value 88
Table 12.1 World pharmaceutical market, 2001
Results of a free-market environmen
area for the 50 top-selling products 102
Table 13.1 US drugs as a percentage of healthcare costs 109
Table 13.2 Number of US launches of innovative medicines, 1990–2000 112
Table 13.3 US biotechnology industry characteristics by selected regi 115
Table15.1 Price ratios for all pharmaceutical catego 131
Table 15.2 Price ratios for ATC groups (list prices)
Summary of pharmac
European countries 132
© 2003 Urch Publishing Ltd v

Foreword
Achieving the best price for a pharmaceutical product is vital for a pharmaceutical
company’s profitability. A clearly defined pricing function can help a company achieve
and maintain higher prices as well as more favourable reimbursement terms. The
Pharmaceutical Pricing Compendium – a practical guide to the pricing and
reimbursement of medicines provides the essential insight into the business, economic,
legal, political and strategic issues that companies must consider when pricing a
product.
Pharmaceutical pricing and reimbursement is complex, controversial and varied. The
global environment is made up of a set of forces, many of which are out of the direct
control of the manufacturer. Companies must contend with numerous variables when
pricing their medicinal products, including:
• healthcare and drug funding systems that differ radically from market to market
• reimbursement and market access increasingly complicated by health economic or
technology assessments
• international reference pricing, already common in Europe, now expanding globally
• considerable parallel trade of pharmaceuticals in the European Union (EU) (which
is now starting to expand to the Middle East)
• access to essential drugs in the developing world, in particular those for HIV and
AIDS, which is very controversial and has led to calls for differential pricing
• in the US, review of drug purchasing by Medicare (coverage for the elderly) and
Medicaid, with managed care organisations shifting the burden to the patient
• the continuing weakness of intellectual property laws in many countries.
This brief list illustrates the obstacles that companies must navigate, not just in getting
innovative medicines to market, but in making products profitable. The Pharmaceutical
Pricing Compendium will help steer the executive through this maze by providing clear
information on the practical business issues that surround the subject. The
Pharmaceutical Pricing Compendium brings together some of the most qualified and
distinguished commentators on pharmaceutical pricing. Authors are company
executives, consultants, health economists, marketers, economists and academics.
Executives charged with delivering profitable prices and reimbursement for their
companies’ products will draw practical, business-critical advice from these expert
papers.
The Pharmaceutical Pricing Compendium is ordered in themes reflecting the issues
currently affecting the pricing and reimbursement sector. Introducing the 14 authored
articles is Mario Nacinovich’s overview (Chapter 1), which succinctly describes the key
issues that pharmaceutical companies have to consider when making a pricing decision.
© 2003 Urch Publishing Ltd 1

Companies pursuing global product launches have identified a troubling tension
between minimising the time to market and maximising prices that determine global
profits. Charles River Associates’ piece (Chapter 2) discusses the approach companies
must take to pricing globally and the constraints that must be overcome. Cecil Nick
(Chapter 3) discusses the merits of considering price issues in the early stages of drug
development which allows companies to create products that demonstrate good value.
Marketing issues
Customer research based on surveys should lie behind all good price decisions. Gary
Johnson’s article (Chapter 4) reviews the types of customer survey methods to assess
price sensitivity and explains the differences between non-trade-off and trade-off
techniques (also known as compensatory and non-compensatory techniques). Life-cycle
management is discussed in Innovative Health Solutions’ article (Chapter 5), which
provides a guide to the key analytical tools, including therapy economics, that
companies must use to ensure optimum performance from R&D to end-of-patent
exclusivity.
Health economic issues
In the past few decades the aim of drug development has always been to produce
effective, relatively safe medicines, but health economic considerations are now gaining
in importance, and the development of a successful product requires integration of the
needs of the purchaser with the already recognised needs of the prescriber and patient.
Brian Lovatt’s article (Chapter 7) argues that, as cost containment becomes increasingly
important in health systems, demonstrating the value of products is becoming essential
to ensure reimbursement. Paul Langley (Chapter 6) develops this theme by identifying
the steps that companies can take to launch a product at a price that is acceptable to the
authorities, customers and the company.
Ethical issues
The controversy surrounding the supply of AIDS medicines to African countries has
tarred the industry’s reputation. There are enough issues here to fill a number of books.
The pharmaceutical companies’ stance has been watched closely by the authorities that
oversee the pricing and reimbursement of medicines. The article by Faiz Kermani
(Chapter 8) summarises the history of AIDS drug supply and the impact on prices and
the generic competitors.
Regional issues
The varied pricing and reimbursement systems of European countries often cause
companies distress. Jorge Mestre-Ferrandiz (Chapter 9) looks at the use of reference
pricing in Europe, which started in Germany in the 1980s and is now commonplace for
launches. He provides a number of detailed case studies of inter-nation price
comparisons and exchange-rate differences. One major problem rising from the single
European market is parallel trade of pharmaceuticals, which, according to Klaus Hilleke
(Chapter 10), is the fastest growing part of the pharmaceutical market. In his article he
runs through the options that companies have to counter the negatives effects of parallel
imports and discusses the long-term future of this controversial business.
Roland Pfeiffer’s (Chapter 11) and Michael Bohn’s (Chapter 12) articles offer useful
insight into the methodologies that companies employ to set prices in Europe. Whether
© 2003 Urch Publishing Ltd2

FOREWORD
companies should sacrifice sales in one country in order to maximise overall
profitability is debated, and Bohn illustrates how pharmaceutical company Schering has
a pan-European approach to profitability and thus price setting.
TIAX’s article (Chapter 13) looks at the US and the impact of the pharmaceutical
industry on the economy. The authors argue that high prices and a free market are
essential to support a strong research-oriented bio-pharmaceutical industry, as spending
on pharmaceuticals takes only 1.4% of GDP.
Legal issues
GlaxoSmithKline’s now infamous case of two-tiered pricing in Spain has yet again
brought the legality of parallel trade into the limelight. Lorna Brazell’s article (Chapter
14) clearly explains the company’s defence and the European Commission’s opinion.
The Pharmaceutical Pricing Compendium brings together a series of useful tables and
figures (Chapter 15) relating to pharmaceutical prices and reimbursement trends. There
is also a short glossary in which terms and jargon specific to the business of
pharmaceutical pricing are defined.
The Pharmaceutical Pricing Compendium will become an essential reference work for
all involved in the business of pharmaceutical pricing and reimbursement.
Urch Publishing
January 2003

CHAPTER 1
The art of pricing in the pharmaceutical industry
Mario R. Nacinovich Jr, Executive Director, Strategic Planning, Fission
Communications (US)
Article summary
There are many elements that pharmaceutical companies must consider when
pricing their products. Recouping the large investment in research and
development (R&D) is a key driver but others such as product life cycle, patent
protection, innovativeness, competition, government controls and corporate
philosophy all have an influence on the pricing decision, thus making pricing
one of the most complex economic decisions.
Keywords
Commercialisation, GATT, GlaxoSmithKline, Price Adopter, Price Innovator,
Pricing Strategy, Optimal Value Harmonisation, Patent, Products Cycle,
Tagamet, Zantac
PHARMACEUTICAL, MEDICAL DEVICE and biotechnology companies have all
become dedicated to a new discipline in their due diligence of bringing any new product
or device to market – the art of advanced price planning. The industry is currently made
up of organisations that range from very small, research-intensive groups funded by
universities and by venture capitalists, to large, multinational corporations. The
innovators in the industry such as Pfizer, GlaxoSmithKline, Merck & Co., AstraZeneca,
Bristol-Myers Squibb and others face issues including required outcomes research,
governmental regulations and controls, validation, healthcare reform, managed care,
decreased patent protection periods, generic competition and ongoing challenges related
to advertising, education, promotion and industry pricing. Figure 1.1 illustrates the
pressures that have a direct or indirect effect on pricing.
Pricing and price planning
Pricing is a dynamic economic logic with principles and policies that are rooted deeply
in a company’s fiscal philosophy. Pricing strategy includes objectives, broad policy,
strategy, implementation and adjustments.
The goal of this philosophy seeks to maximise or optimise the appreciation of the value of
each individual product as it relates to the overall company portfolio and the diverse
global marketplace. Price planning is essential to achieving and sustaining optimum
pricing. Pharmaceutical and biotechnology companies are continuously faced with pricing
decisions, where eventual prices are developed through the direct interplay of a series of
multivariable functions of internal and external challenges. Decisions for the advance of
new pharmaceutical and biotechnology treatments are made on the basis of the product’s
potential for success, and its capacity to recover its outlay and make an equitable profit.

Figure 1.1 The art of pharmaceutical pricing
Industry
Pricing
Advertising,
Education &
Promotion
Outcomes
Generic
Competition Healthcare
Reform
Managed
Care
Patent
Protection
Validation
Regulations
Controls
Optimum
Pricing
Source: Author
The art of pricing
The art of pricing is an approach rooted in the core concepts of marketing and revenue
management. This requires consideration of background issues and influences and some
understanding that the market will accept the logic for the pricing. According to
economic theory, both demand and production costs play a role in determining the price
of a drug. Price, however, can never be the fundamental driver of the sale in
pharmaceuticals; companies need to sustain optimal value harmonisation (OVH), which
is the consideration of the appropriate price valuation. This is the point at which the cost
of producing another unit of drug, and the profits earned from that sale, affords the
incentives for the competition to question investing in drug development.
When a breakthrough drug is introduced, by definition it has no close substitutes on the
market. Demand for the drug is fairly insensitive to price, since there is no alternative
treatment of equal quality and effectiveness. Companies with such products are forced to
focus their creativity and innovation to enhance the value of the product to the physician,
patient and consumer while maintaining the same level of creativity and innovation in
their pricing. One area most companies look to in order to balance these efforts is with
disease management education, where educational initiatives are made to reinforce a
particular image that has been portrayed. An additional area in which innovator companies
lead physicians and the public is in terms of vision or sense of purpose. Innovative
pharmaceutical companies exist for something far more motivating than making money.
The view and value that the pharmaceutical company encompasses is the company as a
research and life-improvement entity. In 1950, George Merck II said:
We try to remember that medicine is for the patient. We try never to forget
that medicine is for the people. It is not for the profits. The profits follow, and
if we have remembered that, they have never failed to appear. The better we
have remembered it, the larger they have been. (Merck)

THE ART OF PRICING
Figure 1.2 The drug development process
Sales
Returns
R&D
Costs
Discovery Development
I II III IIIb IV
Basic
Research
Pre-
clinical
Clinical Testing
Commercialisation
Product
Launch
Marketing
Market
Introduction
Patent
Expiration
Patent
Filed
5–10 years 5–10 years 5–20 years
Source: Author
Discovery, development and commercialisation
Pharmaceutical and biotechnology companies have made substantial investments in
product development and discovery. Without the protection of patents, which make
possible a return on such investments, discovery and product innovation simply would
not happen. The GATT agreement, which, among other legislation, set international
standards for pharmaceutical patent life, declared that new entities would be protected
for 20 years. In most countries, however, manufacturers cannot sell the entity until it has
gone thorough a rigorous clinical development and approval process. This process is
estimated to take between 8 and 12 years of the 20-year patent life.
Assuming the successful completion of this process, this decreases the exclusivity time
that pharmaceutical manufacturers have to sell the product.
There are universally accepted ‘equivalency’ requirements that affect decision making
on patent life and market entry. When a new product is first introduced, patent
protection is determined by the product’s inherent attributes. These requirements
include products with the same active ingredients, dosage forms and labelling.
Regulatory/government officials place additional emphasis on the degree to which the
companies have communicated the value of these qualities to key opinion leaders,
formulary committees and managed care. Relative to the art of pricing in the
pharmaceutical industry, investment in the discovery and continued development of

these compounds is risky and at an incredibly high cost that the research-driven and
manufacturing companies absorb. Even after patents have been granted and a product is
available, these companies continue to research and support activities to better
understand the performance of the product.
Neil Dorward, in his book on the economics of pricing, states:
Actual pricing decisions taken by businessmen have revealed a very complex
decision process. Much of the complexity results from the multidimensional
nature of pricing decisions. They usually incorporate many variables, of which
the number, composition, and relative importance, together with the form of
their interrelationships, can vary between different pricing situations within
the same company.
There exist general principles that these organisations have established in their
guidebooks and corporate policies that outline their basic pricing philosophy that aims
to sell their products at fair and just prices, reflecting the current environment in which
that product is to be promoted. Once the policies have been reviewed and tested the
company outlines specific strategies by which to take individual products (even in early-
stage development) and integrate them into the broader product strategies incorporating
all marketing, managed care, manufacturing, finance, public relations activities and
considerations balancing the development of global or regional pricing strategies that
may be important.
The goal of the pharmaceutical and biotechnology company is to accelerate the
product cycles and time to market. There is also the hope to potentially contain R&D
costs without compromising the rigours of the ongoing clinical development.
Ultimately, an approved product’s price (once available in a national or global
market) is priced to the market. The approved price aims to cover costs for those
developmental areas that do not bear fruit, for patent life and eventual competition
from generic copies which may compete principally on the basis of quality of the
existence of the product, for their support or contracting, for price, or for a
combination of factors, for the need to fund future developments, for the fixed costs
to make the product widely available and for the overall value of the product in the
market or for any combination of these factors.
Table 1.1 Factors influencing a product’s price
• Developmental areas that do not bear fruit
• Decreased patent life
• Eventual competition from generic copies
• Existence of product
• Support or contracting
• Generic pricing
• Need to fund future developments
• Fixed costs to make widely available
• Overall value in market
• Any combination of the above factors
Source: Author

THE ART OF PRICING
Product commercialisation and Glaxo pricing strategy (case study)
In the commercialisation of a new product, a company assumes a position as either a
price adopter or price innovator. The price adopter sets its price according to the current
and anticipated prices in the market. The price innovator seeks to price to market at the
optimum level for each market. Glaxo successfully pursued this approach when pricing
Zantac (ranitidine) (prior to merging with SmithKline Beecham). This case is the single
best representation where innovation in the art of pricing was ultimately the key not
only to a product’s success, but also a company’s overall success.
The innovative pricing strategy, along with strategic, locally based marketing alliances
and effective product positioning, was the three-part process that ensured Zantac’s
entrance and eventual dominance in the global gastrointestinal tract market. Tagamet
(cimetidine), introduced in 1977, had 6 years on the market before the second entrant to
the market, Zantac, was introduced. Reflecting the company’s commitment to
innovation in commercialisation, Glaxo launched Zantac at a significant price premium.
There was already a perception that Tagamet was priced as high as the market would
bear. Zantac set the new benchmark and was recognised as the market leader in 1986
when Zantac topped Tagamet in global sales. Zantac was seen as a superior compound,
in part because of its premium price. This innovative pricing strategy was one of the
factors that facilitated the global, blockbuster status of Zantac across the globe.
The opportunity for an ample return on investment is the basis of the investment itself.
Companies invest time and money to make these discoveries and sometimes, as seen in the
Zantac case, set a new premium over competition. The reason is simple, as the costs for
development of these innovations continue to escalate. The Tufts Center for the Study of
Drug Development has estimated that the full-capitalised resource cost of new drug
development is $802m (year 2000 dollars) compared with a decade ago when the average
cost was estimated to be $231m (year 1987 dollars). Lehman Brothers Healthcare Group has
estimated that R&D costs are as high as $675m per new drug. Boston Consulting Group has
put current average development costs between $590m and $800m for a new drug.
Related Tufts Center research has found that it takes between 10 and 15 years to develop a
new prescription medicine and win approval to market it in the US. The findings were
based on information obtained directly from research-based drug companies.
Regardless of the actual figure, a distinction exists between price adopters and price
innovators in the pharmaceutical market. Some have characterised this in terms of
monopolistic competition, but a more thorough investigation shows that most, if not all,
of the leaders in industry make pricing decisions on a conscious, fully informed,
product-by-product, country-by-country, case-by-case basis.
Table 1.2 Estimates of the average cost of developing a new drug
Estimator Cost ($m)
Tufts Center for the Study of Drug Development 802
Lehman Brothers Healthcare Group 675
Boston Consulting Group 590–800
Source: Adapted from data (see References)

New product development, commercialisation and pricing authorities
Much like the thorough examination of product candidates in the early phases of clinical
research, pharmaceutical companies have dedicated new product development teams to
tackle one of the core considerations as to the likely price a product can direct in the
global marketplace. Primary and secondary audits are analysed and the compound is put
through a rigorous play of projections and field research to determine target pricing and
point of profitability. Once target pricing is reviewed and set, there is the challenge of
setting the optimum price for the individual pricing environment. That ultimately
requires input on a regional or local basis where there are governmental controls that
influence price either indirectly or directly.
These pricing authorities are key decision makers and sometimes act as the rate-limiting
step for a company to achieve optimal pricing. Much like the thought leaders for the
education and promotion of a product through medical education, these individuals and
agencies require effective strategic planning and thorough relationship-building tactics to
recognise the contribution that the pharmaceutical product can bring to their constituents.
The various directives that govern pharmaceuticals relate to registration, testing, pricing,
manufacturing, distribution, classification, and labelling. There is also significant
divergence in the area of pharmaceutical pricing and with regard to the period granted for
product market authorisation. While some countries have determined the criteria for
pricing and have introduced the principle of uniform pricing for domestic and imported
products, the difference is debated mainly on the existence of price controls for
pharmaceuticals produced in the individual country. The art of pharmaceutical pricing
becomes highly variable due to government interference in pricing and reimbursement.
There are common elements that, once understood, can assist a pharmaceutical company
in preparation for handling directives. These elements and their adoption vary but are
standardised to reference specific controls on generic referencing or substitution,
therapeutic category referencing, profit or margin controls, and international referencing.
Understanding the importance of these elements and the relative adoption in each
country helps ensure that specific local price planning meets the therapeutic and
economic guidelines and that the new product offering represents clear value in these
two areas. It is clear that the same dollar buys considerably more in Mexico or Pakistan
than it does in the US or the EU. These issues will be detailed in greater depth in other
areas of the Compendium but are relative to the understanding of the role of the
environmental and governmental factors in the art of pharmaceutical pricing.
Table 1.3 Influences on pharmaceutical prices
Governing directives Government controls
Registration
Testing
Pricing
Manufacturing
Distribution
Classification
Labelling
Generic referencing or substitution
Therapeutic category referencing
Profit or margin controls
International referencing
Source: Author

THE ART OF PRICING
Summary
The cost of bringing a new product through the various stages of clinical trials and
regulatory approval is enormous. Some pundits have argued that pharmaceutical prices
tend to be high because of these costs, while others have argued that it is the high prices
and potential for return on investment that encourage companies to drive innovation at
their own expense. Actions involving prices should be based on conditions in the
marketplace, the activity of competitors, the competitive position of the innovation, the
prevalence and current financial burden of disease, whether the product is a new entry,
and overall strategic and long-term product or portfolio plans.
Crucial to the art of pharmaceutical pricing is to get close to the ‘perfect market
knowledge’ where supply optimally matches demand. There exists a predisposition
that these innovations are an expense to the patients in need. Only after a thorough
review of the philosophies, principles and policies, strategies and tactics, and the role
of global markets can one truly appreciate the art and the impact of pharmaceutical
pricing for each specific pharmaceutical, medical device, and biotechnology company
with a particular product, at a specific time, in a given country and under current
market conditions. The basic tenet of the neoclassical theory on price is that equating
marginal costs and marginal revenue maximises profits. This presupposes knowledge
about the shape of supply and demand curves, and the elasticity of demand for an
item. These innovative products are priced at the value that they bring to the end user,
which in some cases means keeping patients alive and active in our global community
longer and in less costly care settings. That is where product value outweighs the
acquisition cost. These products are to be recognised as therapeutic advances in the
purest form from relief of sickness, pain, suffering and death, and priced to such
value.
References
Boston Consulting Group (June 2001) A revolution in R&D: the impact of genomics.
Available at http://www.bcg.com/publications/files/genomics.pdf (accessed 1
September 2002).
Dorward, Neil (1987) The Pricing Decision. Economic theory and business practice.
London: Harper & Row.
Lehman Brothers (2000) Drug R&D costs, success rates, and emerging technologies: a
look at three future scenarios. In Mathieu, M.P. (ed.), PAREXEL’s Pharmaceutical
R&D Statistical Sourcebook 2000. Waltham, MA: PAREXEL International
Corporation.
Merck (September 2002) Available at http://www.merck.com/careers/culture.html
Tufts Center for the Study of Drug Development (30 November 2001) Tufts Center for
the Study of Drug Development pegs cost of a new prescription medicine at $802
million. Available at http://csdd.tufts.edu/NewsEvents/RecentNews.asp?newsid=6
(accessed 1 September 2002).

About the author
Mario R. Nacinovich Jr is a senior business executive with broad knowledge of the
pharmaceutical, biotechnological and healthcare educational marketing fields, as well as
expertise in a variety of specific disease categories. As Executive Director, Strategic
Planning, Mr Nacinovich is responsible for strategic and tactical development and plays
a leading role in all business development activities with Fission Communications based
in New York City (www.fissioned.com). Fission Communications benefits from being part
of one of the top 50 healthcare advertising agencies, Regan Campbell Ward, which is an
independently branded and managed part of McCann-Erickson Healthcare Worldwide,
the second largest global healthcare agency.
Mr Nacinovich joined Fission as the second executive in this start-up in October of 2001,
after spending the previous 2 years, most recently as Vice President, Strategic Planning,
with Ventiv Health in Stamford, Connecticut. In the Communications division, he was
also named Vice President of Ophthalmology, under an agency contract with Pharmacia
Corporation. In addition he received appointment as a member of the Clinical Advisory
Council, a medical board of directors founded to serve as clinical advisors to support
Ventiv Health, Inc. Mr Nacinovich also served as the Communications division lead for
many developments with Ventiv Integrated Solutions, a separate business unit within
Ventiv Health that offers product introduction and life-cycle management strategies that
improve on risk and return profiles of traditional commercialisation options such as going
alone or out-licensing. Through his 2-year tenure, he also served as Director of Business
Development and in various client services positions while contributing a great deal of
medical writing and core content development for a host of industry clients. Prior to
joining Ventiv in April 2000, Mr Nacinovich spent over 6 years at Merck & Co., Inc., in
New York City, West Point, Pennsylvania, and in Scottsdale, Arizona, in various sales
and marketing management positions.
Mr Nacinovich received his Bachelor of Science degree in Managerial Science, with
minors in Psychology and Economics, from Manhattan College in Riverdale, New York.
He also received a certificate in Political Journalism from Georgetown University in
Washington, DC, on a Bodman-Achelis Foundation Scholarship.
He is an active member of the American Management Association and the Association
for Research and Vision in Ophthalmology. He lives in Danbury, Connecticut, with his
wife and their two daughters. Mr Nacinovich can be contacted via personal email at
nacinovich@att.net or at Fission Communications, 381 Park Avenue South, New York,
NY 10016, USA. Tel: +1 646 742 2123.

CHAPTER 2
Global pricing strategies for pharmaceutical product
launches
Peter J. Rankin, Senior Associate, Gregory K. Bell, Vice President and Tim
Wilsdon, Principal, Charles River Associates (US)
Article summary
This article provides a brief strategic overview of the types of constraints that
manufacturers must overcome in order to implement a successful global
product launch and determine the optimum price.
Keywords
Demand Analysis, Global Launch, Health Outcomes, Market Research, Optimal
Price, Parallel Trade, Prescribing Patterns, Reference Pricing
ESCALATING HEALTHCARE COSTS, increasing sophistication of insurers and
regulators, and heightened investor expectations continue to compel pharmaceutical
manufacturers to become more effective at pursuing all available sources of revenue.
These pressures are emerging globally, with countries seeking a variety of concessions
from pharmaceutical manufacturers. Effective global launch of a new pharmaceutical
therapy must account for reduced pricing freedom and a tangle of country-specific
regulations. Efforts to rationalise regulatory regimes and promote international trade
further contribute to an environment in which pharmaceutical manufacturers must
manage product launches globally in order to meet revenue and profit expectations.
There are many rewards to reap from effective global launches, but today’s approach
requires strategic considerations that might differ fundamentally from past experiences.
Successful global strategies must negotiate profitable prices in a fragmented and
idiosyncratic environment, predict proper launch timing, mitigate parallel import losses,
minimise the effects of reference-based pricing, and establish consistency in pricing and
reimbursement levels across markets and time. An acknowledged effective approach to
global launches allows the development of potentially valuable global brands, generates
in-licensing opportunities and maximises global profits.
Pharmaceutical companies pursuing global product launches have identified a troubling
tension between minimising the time to market and maximising prices that determine
global profits. Limited intellectual property protection and stockholder expectations
(among other factors) often suggest that the best product launch strategy is one that
provides the fastest commercialisation. This mindset is appropriate in countries where
manufacturers are free to set price; however, in countries that require price negotiations
before launch, such haste to enter the market risks sacrificing significant revenues over
the product life cycle.

Of course, this tension is merely the first of many hurdles faced by manufacturers
pursuing global product launches. Others include price maintenance, unilateral
regulatory price changes, managing price negotiations, and sequential launch timing.
Underlying all of these constraints is the spectre of parallel imports, which can magnify
the scope of price concessions by eroding sales in profitable markets.
Determining the global launch strategy
A successful global launch strategy includes far more than determining price. As shown in
Figure 2.1, the typical launch issues, including product positioning, price determination and
reimbursement negotiations, must include an evaluation of the factors that affect the launch
and life cycle of the new therapy. For example, a profitable global launch strategy must:
• demonstrate the clinical attributes of the therapy against products
• protect against the possibility of a generic or new competitive entry
• incorporate each country’s healthcare system and physician prescribing patterns
• cater to country-specific regulatory environments while successfully negotiating
profitable prices.
Price determination should be the culmination of demand analysis based on market
research, account segmentation, health outcomes analysis and evaluation of regulatory
constraints. The significance of different determinants of launch prices varies by
geography; emphasis on health outcomes analysis and the risks of parallel trade is
pronounced in Western Europe whereas the importance of managed care and account
segmentation analysis is dominant in the US. Figure 2.2 provides a summary of these
pricing factors, each of which is described in detail below.
Figure 2.1 Strategic considerations for global product launch
Approval, Pricing and
Reimbursement
Product Positioning
Segmentation Analysis
Optimal Pricing Strategy
Negotiating Reimbursement
Cost Effectiveness
Parallel Trade Effect
Generics
New Products
and Indications
How will they affect
market?
What will
competitive
landscape look
like?
National Regulatory Environment
and Healthcare SystemProduct’s
Clinical
Attributes
Competitors’
Clinical
Attributes
Physician Prescribing Guidelines
Source: CRA

GLOBAL PRICING STRATEGIES
Figure 2.2 Determining optimal global price
Demand Analysis
• Determine prescribing pref erences
• Determine key decision makers and
price sensitiv ities
• Estimate share, rev enue, prof it
curv es
Parallel Trade
• Estimate parallel trade impact: which
countries with what v olumes are at
stake
• Dev ise parallel trade strategy
• Quantify expected value
Segmentation
• Determine negotiating objectiv es:
national pay ers and US accounts
• Prioritise opportunities
• Identify driv ers of therapy uptake
Health Outcomes
• Identify audience members: patient,
pay er, phy sician
• Identify country -specif ic endpoints of
interest
• Construct audience-specif ic models
• Lev erage cost-eff ectiv e benef its
Source: CRA
Demand analysis
Understanding the dynamics of prescription use is of critical importance to developing
an optimal pricing strategy. Across different countries and physician types, the
propensity to use a particular therapy and, as a result, the willingness to pay for a
therapy, vary greatly. Demand analysis focuses on three critical questions:
• Who are the key decision makers for the use of this therapy?
• How do the price sensitivities of key decision makers affect use?
• How do prescribing preference vary across markets of interest?
Key decision makers
A fundamental truth underlies all prescriptions and provides constancy when
considering global product launch: physicians know which therapeutic options are best
for their patient. Provided a new pharmaceutical offers clinical advantages relative to
current treatment methods, physicians, especially key opinion leaders, will motivate
prescriptions, both through their own prescriptions for the product as well as their
recognition of clinical advantages in public forums. Manufacturers emphasise the
importance of a new therapy by recruiting key opinion leaders for clinical trials and
health outcome analyses to boost the credibility and distribution of information related
to their new therapy.

Payers affect therapeutic choice in a less direct but often more substantial manner: by
limiting the class of options from which a physician can select a therapy. Some payers
may not reimburse certain products, or might reimburse only under certain
circumstances (such as when a course of therapy begins in the hospital). Further, the
reimbursement decision allows differential support across therapies; not only can a
payer exclude some drugs from consideration, but that payer can also demonstrate
preferences among covered drugs by altering the degree or ease of reimbursement, as is
the case with multi-tiered formularies in the US.
Patients can play a significant role in the prescribing decision, especially for certain
types of therapies under certain healthcare systems. Granted, patients often defer to their
physicians when considering therapeutic options, but with the increase in ‘lifestyle’
products, the broader availability of health information and direct-to-patient marketing
initiatives, patients increasingly express a preference for a particular therapy. In certain
markets (e.g. the US), patients also have a direct financial incentive to guide their drug
decisions, as cost-sharing requirements can result in higher costs for certain therapeutic
options.
Price sensitivities
As noted above, key decision makers might be price insensitive, depending on the
regulatory structure of the market. Some countries, such as Japan, have regulatory
systems that provide economic incentives for physicians to use certain therapies. Some
European markets discourage physicians from higher priced therapies by establishing
physician budgets for prescriptions. Similarly, countries vary greatly in the degree to
which patient price sensitivity is encouraged or structured in local regulations. Payer
price sensitivity, of course, is a redundant phrase as payers are universally interested in
methods to reduce prices. Pharmaceutical managers should have a firm understanding of
the local dynamics among these three parties when establishing a launch strategy.
Integrating the results of these analyses would reinforce a tailored approach to maximise
returns.
Prescribing patterns across markets
Prescription patterns vary widely across markets, reflecting local epidemiology,
physician preferences, clinical practices and regulation. Clinical guidelines, guided
largely by these local matters, play a large role in influencing prescribing patterns.
Countries often have clinical groups that establish treatment guidelines for certain
maladies or for certain classes of pharmaceuticals. These guidelines typically
encompass more than a single product, which results in a new product being classified
relative to existing comparable therapies. These guidelines can differ significantly
across markets. German physicians, for example, are much more willing to use beta-
blockers for congestive heart failure than physicians in other European markets. In
nearly all markets, including Germany, usage of beta-blockers lags behind the targeted
rate established in clinical guidelines. Which guidelines are followed, the extent to
which guidelines encourage the use of particular products and the speed with which
guidelines are adopted provide significantly different prescription patterns across
countries.

Market research: identifying the demand for pharmaceuticals
The goal of demand analysis is to craft a research agenda that speaks to all three
research questions, while also providing insight into segmentation and health outcome
strategies. Market research provides the raw information to address these concerns, but
only if designed well and fielded correctly. Effective market research must provide
information on all key decision makers. In general, market research should evaluate the
share response to changes in the status of competing products; the share response to
clinical attributes, indications, efficacy and patient profiles; price responsiveness;
physician response to financial incentives and disincentives for prescribing; and patient
awareness and willingness to pay.
The particular market research design used to provide competitive information for a
new product launch depends greatly on the therapy, existing and expected competitors,
key decision makers and clinical factors. However, there are a number of practical
suggestions that apply to market research in general. First, key decision makers must be
placed in realistic trade-off situations. Not only does this provide the most accurate
forecast of market demand, but it also keeps the respondent engaged in the survey
process. Physicians asked to consider an unfeasible collection of product attributes, or
patients asked about their willingness to pay an exceptionally high cost, are likely not
only to provide poor responses, but their frustration regarding poor scenario
construction will most likely limit or reduce the quality of information collected.
Second, market research should consider multiple factors of demand for a new
therapeutic agent. When key decision makers – whether physician, patient or payer –
are confronted with a shortlist of demand determinants, market research is easily
manipulated to fulfil the preferences of the respondent. For example, if market research
on pricing a new therapy considers only the effect of price, respondents to market
research have an incentive to overstate their price sensitivities in order to encourage low
prices. Instead, pricing scenarios should be coupled with other demand factors,
including reimbursement issues, treatment regimens, patient severity and characteristics
of available alternatives. The particular type of market research employed (e.g.
monadic, discrete choice) can also affect the extent to which respondents can
manipulate market research to bias the results.
Finally, the third characteristic of effective market research is short, focused survey
instruments. The instrument needs to focus on the ‘need-to-know’ issues (identified
earlier in the analysis of strategic options for the launch) and not be hijacked to satisfy a
myriad of ‘nice-to-know’ questions. There is an implicit trade-off when considering the
length of a survey instrument: collecting more data from each individual respondent
risks respondent fatigue against the higher cost of a larger sample size (the ‘no data
versus bad data’ scenario).
Armed with effective market research data, manufacturers can understand the dynamics
of prescription patterns for a new product and its competitors. Market research allows
construction of share, revenue, profit-maximisation and competitor-reaction curves for
each global market and market segment. The results of market research analysis can be
evaluated at the subgroup level to inform segmentation analyses and health outcome
trial designs, and aggregated across groups to the national or pan-European level.

Account segmentation
A fundamental first step in determining an optimal price is to prioritise the opportunities
available from those who might purchase or use the therapy, including patients,
physicians and payers. Not all purchasers will have the same sensitivity to price, and not
all will purchase similar volumes. The goal of an optimal pricing strategy is to
accurately predict the price sensitivity, willingness to pay and expected purchase
volumes of customer groups. Effective segmentation analysis will answer four questions
across the global customer population:
• Which segments of the market are price sensitive?
• How price sensitive are these segments?
• What percentage of the total market do price-sensitive segments represent?
• How will competitor responses vary by segment?
Segments can be defined using a number of criteria, such as cost-sharing liability, disease
status, physician type, acute/chronic disease type, payer size and predisposition to generic
use, among others. There is no single correct method to segment the market, as the
appropriate tactic will depend on market and product characteristics. To be successful,
though, a segmentation method must produce segments that are homogeneous within and
heterogeneous among. Once these categories of purchasers have been defined, pre-launch
efforts and strategic focus should obviously be directed to those segments of the highest
priority, typically those segments that exhibit the greatest profit potential.
Health outcomes and pharmacoeconomics
The value of health outcomes and pharmacoeconomic analysis depends largely on the
structure of the local healthcare system. In countries where governments negotiate
reimbursement levels (e.g. France, Spain and Australia), health outcomes research is
essential to demonstrate the cost effectiveness of a new therapy. In countries where
reimbursement is traditionally negotiated with non-government payers (e.g. the US),
health outcomes analysis has traditionally played a less important role (though health
insurers in the US increasingly recognise the value of health outcomes research).
An effective global launch strategy must incorporate health outcomes research. Not only
can an effective health outcomes strategy help to demonstrate the efficacy of a new
therapy, compelling health outcomes research can speed time to market by anticipating
the clinical or cost-effectiveness concerns of regulators. To achieve this end,
manufacturers must conduct a basic evaluation of health outcomes needs in the principal
countries for commercialisation well in advance of regulatory filing. In fact, clinical
trials data used in health outcomes research should be structured to include endpoints of
interest to countries of interest. Such anticipatory planning requires that manufacturers
identify issues and endpoints of interest sufficiently far in advance to structure the
clinical trials to include these endpoints.
Such foresight is often elusive, but the pay-off is often worthwhile. Anticipatory data
collection can obviate the need for costly follow-up trials. Addressing country-specific
concerns in advance can avoid costly delays in the time to market for new product launch

or restrictive product labelling. Finally, compelling cost-effectiveness data can constitute a
powerful tool in price and reimbursement negotiations with regulators and private payers.
Parallel trade
The risk of parallel trade, not to mention the court of public opinion, requires that a
profitable global launch strategy explicitly consider price differentials across markets.
Parallel trade describes the process in which large price differences among country
markets makes it profitable for an arbitrageur to purchase pharmaceuticals in one
country market and sell them in another. Parallel imports are particularly prominent in
the EU, where trade liberalisation efforts have minimised the costs associated with trade
while disparate regulatory policies have encouraged price differentials across markets.
Expected enlargement of the EU will only exacerbate the range of price variability.
Parallel trade diverts additional product revenues from the manufacturer to those who
move the pharmaceuticals from one market to another. Spain is a standard example.
Low prices have led arbitrageurs to purchase pharmaceuticals in Spain and export them
to countries with higher prices, such as Germany or the UK. In such a transaction, the
manufacturer loses the value of the sale in the importing country, realising only the
lower priced sale in Spain.
In addition, parallel trade imposes other costs on manufacturers, including market
forecasting, liability assessment and mitigation, and volatile manufacturing
requirements. The liability assumed by the manufacturer when a product packaged in
one country and distributed in another (which might have a different national language)
is often unclear, leaving manufacturers to assess and address potential claims.
Manufacturers must also forecast the sales for both exporting and importing countries in
order to minimise the risk of product shortages or unexpected production runs.
Manufacturers can work with local governments to address some of these concerns. For
example, some countries are experimenting with ‘clawback’ policies intended to recoup
some of these profits accruing to parallel traders, but these benefits accrue to payers (or
patients) rather than pharmaceutical manufacturers.
Understanding the potential effects of parallel trade is complicated by several emerging
trends. First, the increasingly extensive price negotiation required in some country
markets generates uncertainty regarding the eventual price band for the new product.
More troubling is that many countries use reference pricing policies, which potentially
increases the number of markets from which parallel trade exports could ensue by
basing reimbursement on countries with the lowest prices/reimbursement levels. Each
of these issues is now explored in detail.
Price negotiations
A stark and immediate consideration for pharmaceutical manufacturers used to launching
pharmaceuticals in the US, UK or Germany is that few other global markets allow free
pricing. Instead, there is often a period of time between regulatory or technical approval
and commercialisation, during which manufacturers negotiate with regulators to establish
the price at which the new product will be marketed, or at least reimbursed.
Price negotiations are often protracted. In France, price negotiations have an average
duration more than twice that for the rest of Europe. In addition to price, these

negotiations might also require other concessions by manufacturers. In the UK, for
example, manufacturers are constrained by a specified level of profitability. Other
countries, such as Spain, require manufacturers to commit to predetermined sales
targets. Manufacturers are held accountable for recouping the cost of sales that exceed
volume commitments, either by reducing prices or by directly paying back profits.
There are well-documented cases of manufacturers rushing negotiations in order to
launch as quickly as possible, only to realise that the gains from a quick
commercialisation did not outweigh the cost of reduced reimbursement levels resulting
from abbreviated negotiations. Clearly, manufacturers must approach these negotiations
with care and careful preparation. Quick commercialisation is not always ruled out,
however. In some countries, such as the UK and France, effective strategies often hasten
negotiations not by acceding to price reductions, but instead by agreeing to labelling and
use limitations on their products. Once a quick launch is achieved, at a favourable
reimbursement rate, subsequent clinical trials can expand product labelling.
Manufacturers anticipating this strategy can even prepare the subsequent clinical trial
framework before negotiations begin.
Reference pricing
The concentration of purchasing power to payers (often government agencies) in global
markets is of little consequence to optimal pricing without other regulatory constraints.
As has become well publicised, though, many regulatory agencies have pursued a host
of methods intended to limit the prices that a pharmaceutical manufacturer can charge.
One example of these policies is reference pricing. Under a reference pricing framework
the price of a pharmaceutical therapy is affected by the price of a reference drug. The
reference product might be another drug in the same therapeutic class; it might be a
drug with the same clinical indications; and it may or may not be available in the
country of interest. Canada, for example, sets drug prices by comparing with prices
charged for that drug in the US and several European countries. Australia exercises firm
reference pricing with reimbursements capped at the reference price.
Reference pricing has two immediate effects on pricing for product launch. First, some
countries are considering a form of retroactive reference pricing, which would constrain
a manufacturer’s ability to use launch timing and life-cycle pricing changes to maximise
profits. Second, the existence of reference pricing policies ‘ups the ante’, or increases
the pressure on pharmaceutical manufacturers to avoid selling at a low price, as that low
price could be used to affect pricing in other countries that use reference pricing. The
strategic implications of both effects are explored below.
Reference pricing effects on timing decisions
Retroactive reference pricing may place further restrictions on pricing strategy, limiting
some of the rationale that used to support a sequential entry strategy for a global launch.
Unless a sequential strategy is mandated by regulatory requirements, intellectual property
concerns, or production or distribution capacity constraints, retroactive reference pricing
can limit the cost of an immediate rollout in every market of interest. For a country that
practises retroactive reference pricing, a subsequent launch in another country at a lower
price may force the manufacturer to reduce the price in the first country and refund the
difference between the price charged initially and the new, lower price.

Reference pricing effects on pricing strategy
In completing regulatory dossiers to seek clinical or technical approval in global markets,
manufacturers often have the opportunity (and perhaps obligation) to report the anticipated
prices, sales volumes, reference products and clinical indications of their therapy. There are
obvious strategic issues inherent in the approach taken in these dossiers, where
manufacturers have the chance to affect regulatory consideration of their therapy. While
these dossiers are usually country specific, they often share a core of information (such as
clinical trials data) that is common across countries. The extent to which clinical trials and
health outcomes analysis anticipates global launches and incorporates this information into
the structure of the studies (e.g. trial location and demographic populations, or health
outcome endpoints of particular interest) will affect the latitude enjoyed by the manufacturer
in addressing idiosyncratic concerns of individual regulators.
Pharmaceutical manufacturers have two strategic choices affected by reference pricing,
assuming that the necessary clinical and regulatory information is available. First,
manufacturers can choose a limited number of countries in which they would like to
commercialise their product. Because of reference pricing, it might be a (global) profit-
maximising strategy to avoid launching a product in certain countries. For example,
several manufacturers have avoided commercialising a product in France, both in
recognition of the protracted length of negotiations and the possibility of a low
reimbursement price triggering lower prices in other markets that use reference pricing.
The second strategic option available to manufacturers is to craft a globally consistent
price negotiation strategy. The most commonly cited example of such a strategy involves
the use of price bands.
Price bands
Price bands define the allowable difference in prices across global markets. As depicted
by the hypothetical situation in Figure 2.3, the narrowest price band is a single price
charged in all markets. Such a price eliminates the concern of reference pricing, but also
restricts a manufacturer from realising the highest global profit levels. For instance, in
Figure 2.3, the single price is too high to maximise profits in Spain and too low to
maximise profits in Germany (the profit-maximising price corresponds to the highest
point on the profit curves of Figure 2.3 for each country). Alternatively, wide price
bands allow some differences in prices across countries. Such price differences might
allow for some negative effects due to parallel trade or reference pricing, but they also
provide additional latitude to reach the profit-maximising price in more markets. Figure
2.4 demonstrates that a 15% price band would allow a manufacturer in these
circumstances to charge a different profit-maximising price specific to each of the five
country markets.
While they provide a useful heuristic tool for the evaluation of pricing strategy, price
bands face limitations. The degree of success attainable from a price band strategy
depends on the willingness of a manufacturer to walk away from reimbursement
discussions that do not comply with the global strategy. In a manufacturer’s favour, a
demonstrable price band strategy might provide support for requested prices in
reimbursement discussions. Just as likely, however, a price band strategy increases the
relevance of each negotiation, effectively increasing the bargaining power of regulators,
many of whom already enjoy significant advantages as near-monopoly purchasers.

Figure 2.3 Price bands: no variation
€ 5
€ 15
€ 25
€ 35
€ 45
€ 10 € 12 € 14 € 16 € 18
Parallel trade risk lowest with single price and no price discrimination
Price at €11.55 across
EU yields €162.77 profit
France
Spain
Italy
UK
Germany
Source: CRA
Certainly, parallel trade is not only an issue under a price band strategy; after all,
parallel trade will develop whenever there is a sufficient price differential among
markets, whether the result of a price band strategy or not. In fact, it is the price
differential between markets encouraging parallel trade that places an upper bound on
the potential success of a price band strategy. Of course, reference pricing will magnify
the consequences of any sub-optimal result of pricing negotiations by increasing the
number of markets from which parallel trade exports could ensue.
Conclusion
Manufacturers that have grown accustomed to the pricing freedom afforded by certain
markets such as the US are likely to encounter severe strategic challenges when
attempting a global product launch. Price restrictions, including reference pricing, profit
limits, price reductions and other measures combine to create a global market with price
constraints growing increasingly numerous. Launching in any country may have
immediate ramifications in other countries, and unfortunate pricing decisions can spread
to several markets despite the best efforts of the manufacturer. In this increasingly
complex global marketplace, manufacturers must use segmentation analysis, health
outcomes research, parallel trade evaluation and demand analysis to craft a coherent
global pricing strategy that anticipates regulatory entanglements. While difficult, the
profits of an effective comprehensive global launch strategy more than justify a
concerted strategic effort.

Figure 2.4 Price bands: increasing price discrimination
€ 5
€ 15
€ 25
€ 35
€ 45
€ 10 € 12 € 14 € 16 € 18
Profit
Parallel trade likely but with potentially higher profit
15% price band increases
profit to €166.54
Germany
France
UK
Italy
Spain
Source: CRA
About the authors
Peter J. Rankin, PhD, is a Senior Associate in the Pharmaceuticals Practice
(Washington, DC). Tel: +1 202 662 3935; email: prankin@crai.com
Gregory K. Bell, PhD, MBA, is a Vice President and the Pharmaceuticals Practice
Leader (Boston). Tel: +1 617 425 3357; email: gbell@crai.com
Tim Wilsdon, MSc, is a Principal specialising in Finance (London). Tel: +44 20 7664
3707; email: twilsdon@crai.com
About Charles River Associates (www.crai.com)
The Pharmaceuticals Practice at Charles River Associates provides consulting services
to leading firms in the pharmaceutical, biotechnology and medial device industries
across North America, Western Europe, Japan and Australia. Its emphasis is new
product launch strategy, product pricing and contracting, and strategic responses to new
market entrants. It specialises in the economics of business strategy, and its
recommendations are based on quantitative analyses using game theory, marketing
science, finance and econometrics.

CHAPTER 3
Integrating pricing and reimbursement needs into drug
development
Cecil Nick, Senior Consultant Worldwide Regulatory Affairs, PAREXEL
International (UK)
Article summary
There is increasing need for drug development teams to take into account the
cost effectiveness of new products. Pricing and reimbursement needs can be
integrated into the development programme, thereby allowing companies to
demonstrate to purchasers that products represent good value.
Keywords
Comparator, Cost Effectiveness, Dose Ranging, Efficacy, Drug Development,
Indications, Target Population, Safety
DRUG DEVELOPMENT HAS delivered dramatic victories in the treatment of human
disease, but these victories have come at a price. For a start, there is the ever-present
risk of adverse effects, which has to be balanced against any potential benefit. These
risks can be exacerbated if quality and safety are compromised during drug
development, as has been exemplified by a number of past problems such as the
thalidomide incident in 1962. Such incidents fuelled the demand to control the sale and
supply of medicinal products and led to the global mushrooming of regulations, with the
need to demonstrate quality, safety and efficacy prior to medicines being granted access
to the market.
These increases in regulatory demands, however, also come at price, a price that
inevitably has to be borne by the consumer. New and expensive health technology is
further fuelling the demand on the healthcare providers’ purse so that the need to control
costs has become a high priority amongst healthcare providers.
The problem is that medicines are a unique commodity, where the person placing the
order (the prescriber) neither pays for nor uses the product. When the drug works, the
prescriber and the patient are happy, regardless of costs; but not so the purchaser, who
seeks not only effectiveness but also value for money. These purchasers are becoming
more vociferous, demanding data to demonstrate that they are receiving such value. As
a result, pharmaceutical companies are being confronted by a new hurdle, the so-called
fourth hurdle – the need to demonstrate not only quality, safety and efficacy but also
value for money; inevitably, this can be achieved only if the product is value for money.
Health economists may be able to build a case for cost effectiveness, but healthcare
providers frequently employ their own health economist to unravel any misconceptions
built into the arguments provided by the pharmaceutical manufacturers.

Thus, in addition to safety and efficacy, there is an increasing need for drug
development teams to consider issues such as:
• the cost and cost savings associated with the use of the product
• in which populations use of the product will prove cost effective
and, the most critical question of all:
• how the cost benefit of the new product compares with current practices.
So demonstrating that the candidate drug promises a positive risk benefit needs to be the
beginning of the development selection process. There is also the need to assess whether
the product will provide a positive cost benefit. This depends on numerous factors but a
key factor is the cost of drug development. Development costs represent an enormous
outlay that needs to be recouped, and so inevitably impacts on price. These costs need to
be further balanced against the risk of failure, which in the development of
pharmaceuticals is high. It has to be appreciated that the revenue from a successful
product needs to cover not only the cost of its own development but also that for the
many products discarded in its wake. These costs will need to be recouped over the
patent life of the drug and thus an extended development programme that erodes the
patent life of the product will also impact on pricing. Manufacturing costs, too, are a
consideration but are usually of little significance for novel products except for complex
biotechnology products.
The need to demonstrate cost effectiveness needs to permeate the entire drug
development programme. There are a number of areas where pricing and reimbursement
needs can be integrated into the development programme. These include: choice of
indications, choice of target population, study design, choice of comparator, dose
ranging, efficacy studies and safety studies.
Choice of indications
The choice of indication will impact on the willingness to pay for the treatment. For
example, treatment of a mild illness will not significantly impact on healthcare costs or
the patient’s quality of life and, therefore, is unlikely to command a high price. In fact,
even those treatments for severe disease that offer the potential for significant health
gain may not justify a high cost if effective cheaper treatments are available.
The prevalence of the illness is clearly another critical factor. Yet treatments for rare
diseases, although representing a small market, may nevertheless justify a high price
because the low prevalence will have little overall effect on healthcare budgets. Thus,
such treatments can generate sufficient revenue to cover the cost of development,
particularly if the product qualifies for orphan drug status, so entitling government
incentives that may contribute to reducing the development cost to the sponsor.
Patient population
The population to be treated can profoundly affect pricing considerations in a number of
ways. Clearly, the benefit will be maximised if the proportion of patients responding to
treatment is enriched by careful selection utilising techniques such a genotyping,

PRICING AND REIMBURSEMENT NEEDS IN DRUG DEVELOPMENT
phenotyping, novel diagnostic techniques, or a brief trial treatment. However, these can
prove costly and may be of value only where the drug is expensive to manufacture since
the ‘shotgun’ use of a proportionally lower priced medicine in a larger patient
population will have the same impact on overall costs and revenue. Nevertheless, such a
shotgun strategy does present risks in that if in the future it becomes easier to identify
responsive patients, this will significantly impact on future return on investment.
Additionally, if the sponsor subsequently decides to develop the product for new
indications in more easily identifiable but smaller patient populations, it may not be
possible to recoup the development costs based on the low prices already established.
Another factor is the geographic and social distribution of the disease to be treated, for
the value of the treatment is intricately linked to the ability to pay for it. Thus,
treatments developed against diseases of the rich are likely to generate more revenue
than those intended for use in the developing world, a stark but real problem that has
been graphically highlighted by the African HIV epidemic.
The age and health of the target population are other critical factors to consider. For
example, saving a young life will most likely generate many more productive years
compared with those gained for an elderly and possibly disabled person. The value that
health providers place on a life will, of course, vary, and published figures are not easy
to come by since they are based on complex and emotive decisions and are difficult to
defend on a case-by-case basis. However, in the Western world in general, values of
£20,000–50,000 per full-quality life year saved are usually considered acceptable. On
this basis, a treatment course that on average provides 60 years of good quality life
might justify an expenditure of £1,000,000 to £3,000,000, although one would normally
discount this by 5% per annum (cumulative average), which would more than halve
these figures. On the other hand, a treatment that provides an 80-year-old patient with
say 5 more productive years will justify an expenditure of £100,000–250,000 (and less
if discounted at 5%). But often the extended life is not of full quality. To deal with this
problem, health economists have introduced the concept of the quality-adjusted life
year, or QALY. This adjusts the numerical value of a life year by the quality of that life.
Numerous quality-of-life assessment systems have been introduced, all of which can
provide good estimates.
The value of life is important, but is just one aspect that health providers have to
consider. Equally important are the costs associated with caring for the ill and the
impact a new treatment might have on delivering cost savings. For example, the H2
antagonists and newer proton pump inhibitors have considerably reduced expenditure
on surgery for gastric ulceration. Such benefits need to be evaluated and quantified
during drug development in order to enable justification of pricing to the healthcare
purchaser.
Dosage and route of administration
The way in which medicines are used will also impact on cost. For example, parenteral
administration will increase costs by requiring the use of sterile syringes, although these
may be insignificant when compared with the cost of the medication. Nevertheless,
more novel routes of administration might contribute more significantly – for example,
the pulmonary delivery of proteins may demand the need for complex administration

devices, and the need to administer drugs as intravenous infusions may necessitate an
extended hospital stay, thereby contributing significantly to expenditure.
Dosage, too, may impact on price in numerous ways, the most obvious – but usually the
least important – being that high doses require utilisation of higher quantities of drug
substance. However, unless manufacturing costs are relatively high, this will have a
marginal impact. In fact, perhaps of more importance is the potential need this might
generate for increased shelf space in pharmacies.
Of much greater importance is the need to get the dosage right, because prices have to
be set against predicted usage in order to deliver the target revenue. Should it be
discovered subsequently that a lower dose gives equivalent efficacy, generally it would
not be possible to raise prices to cover any consequential shortfall in revenue.
Another issue that might be faced is where dosage requirements vary considerably from
one patient to another. As much of the cost of a new medicine arises from its
development rather than its production, it seems unfair that a patient who requires twice
the average dose is saddled with twice the cost. To accommodate this, suppliers may
often set their price per dosage unit rather than per milligram of drug substance. This
approach is acceptable provided one is not dealing with a multi-dose presentation such
as insulin. But even then if these costs are borne by state or other large healthcare
systems, this will average out. There is clearly a problem, however, where patients have
to pay for their own treatment and for rare diseases requiring costly therapy, whereby a
healthcare provider can find that one patient requiring high doses of a drug can
adversely impact annual budgets, a notable example being the treatment of a
haemophiliac inhibitor patient suffering a major bleed. Complex arrangements such as
price capping agreements can be used to circumvent these problems but these can prove
difficulty to administer.
From a different perspective, the frequency of dosing may also impact on cost (albeit
indirectly) by reducing compliance, for example, which in turn will reduce clinical
effectiveness and consequently cost effectiveness.
Choice of comparator
Regulators require incontrovertible proof of efficacy; this usually requires placebo-
controlled studies. However, it is unusual for a new drug to represent the sole treatment
for a particular indication, and the purchaser will be interested to know how the new
treatment compares against current treatments. In fact, this is not at odds with the
requirements of EU regulators who are also interested in the relative safety and efficacy
of the new product compared with the ‘gold standards’ currently in use. But choosing
the ‘gold standard’ is often not as easy as it sounds. Firstly, the comparator that might
interest the purchaser may not yet have been launched. Secondly, the regulators and
purchasers may have different views of the ideal comparator. For example, a less
effective but commonly used less costly comparator may be preferred by the purchaser,
although this will present a huge hurdle when it comes to pricing discussions. On the
other hand, the regulators might consider such a comparator to be outdated. Clearly, the
sponsor will need to navigate these differences whilst bearing in mind the need to
convince both parties.

Other issues that might confound the choice of comparator are:
• different practices in different regions
• difficulties in blinding (e.g. different dosage form, dosage schedule, adverse events)
• those circumstances in which the gold standard comparator represents first-line
treatment and the new drug does not.
Furthermore, it is clearly important that any comparisons are fair, and thus it is
extremely important to ensure appropriate comparison of dose and frequency of dosing
when performing any comparative study.
Clinical effectiveness
Whereas the regulator’s interest is efficacy, the health economist focuses on clinical
effectiveness; that is, the impact on the patient’s overall well-being when the medicine is
used in a natural setting rather than a clinical trial. Clinical effectiveness measures include
quality of life, morbidity and/or mortality. Regulators tend to be less comfortable with
quality-of-life assessments because of their perceived arbitrary nature, although this
science has progressed considerably over recent years and is becoming more widely
accepted. Certainly, regulators will have no difficulty with patient survival. The key
difference, however, is that regulators are a little more amenable to accepting surrogate
endpoints, if validated. However, this is built on pragmatism rather than preference, as
survival studies may sometimes need to run for decades. Health economists therefore also
have to accept surrogate endpoints, albeit reluctantly, and deal with this by mathematical
modelling. Thus, there is a strong, although not perfect, overlap between the needs of the
health economist and the regulator when designing efficacy studies.
But what about the trial setting? It is true that early regulatory studies are conducted under
strictly constrained conditions. However, later in the trial programme it becomes
important to simulate the intended usage conditions in order to assess safety in the broader
population. Some constraints in phase III trials are unavoidable as it is important that the
interests of the patient are protected and the potential for a successful trial is maximised.
But this is a compromise that health economists have to live with if they want data at the
time of regulatory approval. Thus, providing protocol constraints has a sound basis and, if
kept to a minimum, should not devalue the outcome data to any significant degree.
Safety
For a new chemical entity, regulators will normally require that at least 1,500 patients
are exposed to the new drug in order to detect adverse events with a frequency of 0.1%.
Furthermore, if long-term use is intended, 300–600 patients should be treated for at least
6 months. Health economists will be extremely interested in these safety results, as
adverse effects will detract from any benefit and could contribute to the costs of patient
management. However, the health economist will have a keener interest than the
regulator in segregating drug-related adverse events from those unrelated to the
treatment so as to enable calculation of the impact of treatment over the background
effect. When ethical, this can be achieved by including a placebo control group to
provide a baseline for adverse events. Statistical advice will need to be sought, but often
several hundred patients treated with placebo may suffice.

Cost effectiveness
Clearly, the health economist’s prime interest is the cost effectiveness of a new
medicine and in order to calculate this there is a need for cost data. These data are not
normally generated in clinical trials and in any case vary from one region to another.
However, cost drivers can be researched during the clinical trial programme. Such
drivers include:
• days in hospital
• number of laboratory tests required
• consumption of test compound
• total consumption of medicines
• number of additional diagnostic procedures required
• hours of nursing care.
These cost drivers can then be converted to costs using local data accrued in separate
research.
There are difficulties, however, associated with determining cost drivers in registration
studies. One of the key problems is that regulatory trials require numerous assessments
that can mask the need for the actual numbers of consultations and tests that may be
required in a more natural setting. There are ways of dealing with this, however (see Nick,
2001). In any case, such costs are frequently insignificant compared with overall costs.
Conclusion
The focus on the escalating costs of medicinal products is unlikely to disappear.
Willingness to pay represents a critical factor contributing to these ever-rising costs.
However, the role of product R&D costs is certainly considerable and not fully
appreciated. More targeted and focused research could, therefore, have a favourable
impact on cost in the long run. In the past few decades the aim of drug development has
always been to produce effective, relatively safe medicines, but health economic
consideration are now gaining in importance, and the development of a successful
product requires integration of the needs of the purchaser with the already recognised
needs of the prescriber and patient.
Reference
Nick, C. (2001) In pursuit of clinical excellence. The Regulatory Affairs Journal 12(2),
100–104.
About the author
Cecil Nick, BSc (Hons), FBIRA, has over 20 years’ experience in pharmaceutical
regulatory affairs. He has extensive experience in the development and EU registration of

products of biotechnology, other biological medicines and new chemical entities. He is a
Fellow of the British Institute of Regulatory Affairs and has published many articles on
clinical regulation. Cecil can be contacted at PAREXEL International Ltd, River Court, 50
Oxford Road, Denham, Uxbridge, Middlesex UB9 4DL, UK. Tel: +44 (0)1895 614589;
email: cecil.nick@parexel.com

CHAPTER 4
Assessing the pharmaceutical price modelling tools
Gary Johnson, Managing Director, Inpharmation Ltd (UK)
Article summary
Most pharmaceutical companies rely on surveys to set prices but such survey
techniques have unavoidable biases. Also, some key customers – particularly
payers – are difficult or impossible to survey. This article explains why simple
econometric techniques should be considered in order to provide powerful
guidance and how these techniques can boost the accuracy of price predictions
even when it is possible to undertake surveys. Lastly, the author explains why
health economics are best reserved for price advocacy rather than price setting.
Keywords
Conjoint Analysis, Compensatory, Non-trade-off Techniques, Price Forecasting,
Surveys, Trade-off Techniques
MANY PHARMACEUTICAL COMPANIES use market surveys to support their
pricing decisions. The reasons cited for this are that it is a good idea to be customer
focused (true) and that therefore it is possible to determine what customers are prepared
to pay simply by asking them (not true). The problem is that survey techniques tend to
produce biased results.
There are many survey techniques that can be used to assess price sensitivity, but
broadly these can be split into two types: non-trade-off techniques and trade-off
techniques (technically known as compensatory and non-compensatory techniques).
Non-trade-off techniques
With this type of technique the customer is asked for a response to the price. For
example, one might say: ‘Here is the profile of a new product; at what price do you
think you would not prescribe this product because you think it is too expensive?’ By
aggregating the responses of many customers to such a question, one can create a price–
demand curve. So, for example, at a price of $1 none of the customers surveyed said
that their ‘stop prescribing price’ was this low, thus relative demand at this price is
100%. But at a price of $2, 50% of respondents said that their ‘stop prescribing price’
was below $2. Thus relative demand at this point is $2. In this manner it is possible to
build up the implied price–demand curve from the survey.
This is a simplified account of how these techniques are applied in practice and there
are many elaborations and variations on this theme. This brings us to the first point
about these techniques: there seems to be no evidence that more complex variations on
this theme are any more effective than the simpler versions. In fact, a review of the

forecasting literature shows that whenever investigators have compared the performance
of simple and complex methodologies, the simple versions are always at least as good
as the complex alternatives.
The second point to appreciate is that non-trade-off techniques seem to be
systematically biased. Not only do they have an error but, specifically, these techniques
tend to overestimate sensitivity to price or, put another way, they tend to underestimate
the price that a company can charge for a product.
The reason why these non-trade-off techniques tend to overestimate sensitivity to price
is that they focus the respondent’s attention much more on price than on the other
product features.
Because of this bias, non-trade-off techniques fell out of favour somewhat in the 1970s
and 1980s and were replaced by trade-off techniques.
Trade-off survey techniques
The central idea behind the techniques is to encourage customers to consider all key
product attributes and to weigh one against the other. Trade-off techniques consider
products to be ‘bundles of attributes’. They assume that it is possible to isolate the effect
that each attribute has on a customer’s decision regarding which product to choose.
Consider this very simple example of a product that has only two attributes: efficacy
and price. Let us pretend that each attribute can have one of two levels. Efficacy can be
high or low and price can be either $1 or $2.
Now it is obvious that respondents would prefer to have a combination of high efficacy
and low price. It is equally obvious that they would least favour a combination of low
efficacy and high price. But it is not obvious whether they will prefer high efficacy and
high price or low efficacy and low price. It is not obvious because this choice requires
the respondent to trade-off the value of high efficacy against the value of low price. If
we ask respondents to make this choice and they favour high efficacy and high price to
low efficacy and low price, we can say that (for the levels considered) efficacy is more
important than price.
The actual techniques used are more elaborate than this. The most popular elaboration is
a technique called conjoint analysis. Conjoint analysis was introduced into market
research in the late 1970s. It takes its name from the fact that it asks respondents to
consider attributes jointly (conjoint = considered jointly). Respondents choose between
product profiles (or partial product profiles). It is then possible to recombine the
different attributes into a vast number of hypothetical combinations and predict to what
extent respondents will like these.
Key aspects of trade-off techniques
The two key points to appreciate about trade-off techniques are exactly the same two
factors that were stressed for non-trade-off techniques. Firstly, the more elaborate
techniques have delivered no improvements in the accuracy of their predictions.
Conjoint analysis, because of its popularity and high cost, deserves special mention. A
recent systematic review of studies published in leading peer-review journals concluded

ASSESSING THE PHARMACEUTICAL PRICE MODELLING TOOLS
that conjoint studies are no better at predicting than much simpler techniques known by
the unfortunately technical term ‘self-explicated techniques’. These techniques are
simpler because, rather than asking for responses to bundles of attributes and then using
statistics to infer the importance of individual attributes, respondents are simply asked
directly for this information. Proponents of conjoint analysis provide many plausible
reasons why their more sophisticated techniques ought to make better predictions.
However, when the experiments have been done, the predictions prove to be no better.
The second point to appreciate is that these trade-off techniques – just like the non-
trade-off techniques – seem to have systematic bias. There are two key reasons for this
bias:
1. People respond to a written product profile and they assume that it is not a full
description. In the absence of a full description, they assume that price is a proxy
for a product’s performance on missing attributes. So, they are less sensitive to
price than they would be with a real product.
2. When people are given a bundle of product attributes, they tend to focus on the key
ones. This happens particularly when the task is hurried or trivial. Both of which are
the case in market research. (Market research decisions are faster and less important
than real clinical decisions.)
Of course, we can attempt to overcome these biases. Unfortunately, efforts to alleviate
one of the above biases tend to make the other source of bias worse. For example, we
can use partial product profiles – sometimes consisting of just two attributes – so that
price does not get ignored, but such massively incomplete product profiles will serve to
aggravate price being used as a proxy for quality.
So, where does this leave us? The older non-trade-off techniques were abandoned
largely because of a bias to overestimating price sensitivity. The solution of trade-off
techniques seems to have the opposite bias of underestimating price sensitivity.
The solution: combining price forecasts
The solution seems obvious: the results of the non-trade-off and the trade-off techniques
should be combined. This, it turns out, is not just a pragmatic solution to this particular
problem. Four decades of academic pricing research have shown one thing beyond
doubt: a combination of different forecasting techniques – and the more varied the
better – almost invariably provides a more accurate prediction than any one technique
alone. And how should these different results be combined? Again, forecasting research
suggests that it is difficult to beat the simplest and most obvious solution – just take a
simple average.
Going beyond surveys with econometrics
Combining the two main types of survey-based pricing techniques is a good idea. But
why stop there? Are there other techniques that can be brought to the forecasting
process? Happily, the answer is yes. This is a good thing not only because combining
more techniques will give us greater accuracy, but also because there are some key
pricing questions that are difficult to answer with surveys.

Take, for example, the issue of payers. This catch-all term is used to describe the people
or bodies who pay for pharmaceuticals and decide whether particular products are made
available for doctors to prescribe. Payers could include pricing and reimbursement
authorities, managed care organisations or hospital formulary committees.
It is usually difficult to survey payers effectively – especially regarding how they will
respond to a specific drug. Past behaviour is generally a better guide to how people will
act in the future anyway, and there is a long record of past behaviour that we can
analyse to help us make predictions. Statistical analysis of past market behaviour is
known as econometrics. This sounds daunting, but actually the most useful econometric
analyses in pharmaceutical pricing are very simple. So, how might we go about
conducting an econometric analysis to predict payer behaviour? Usually, this means
taking obvious aspects of payer behaviour and analysing them statistically. In other
words, we look at factors that are obvious and that almost certainly form a part of any
judgement that would be taken on what price payers would support.
For example, we all know that payers tend to grant higher prices to products that treat a
smaller number of patients, and this can be taken into account when estimating a
reasonable price. And, indeed, when we analyse a large number of payer decisions
mathematically we find that there is an impressive link between patient numbers and the
decision to reimburse. So, why analyse the relationship between payer support and the
number of patients that a product can treat statistically when we already know that this
factor is important and take it into account? The answer is that a huge number of studies
show that this leads to more accurate forecasts – statistical models are usually better
than expert judgement.
Obviously there are other factors, apart from the number of patients treated, that have to
be included in a statistical analysis and it is not only payer decisions (but also doctor
decisions etc.) that are amenable to this sort of econometric analysis. The point to note
is that these techniques can reasonably be expected to further enhance the accuracy of
price predictions and can give insights into areas that are difficult to probe with surveys.
Again, it is worth noting that, in studies, complex econometric methods perform no
better than simple ones – so one should maintain a healthy suspicion of ‘sophisticated’
techniques that one does not fully understand.
Health economics and pricing
It will be apparent that so far there has been no comment on the use of health economics
in pharmaceutical pricing. This may seem strange, particularly as many pharmaceutical
companies combine their pricing and health economics functions.
The reason why health economics is left until last is that is has a minor role in
pharmaceutical price setting. This is not to say that it has no role, nor is it to say that it
does not have a major role in price advocacy.
However, for pharmaceutical price setting, the role is minor for the following reason.
Health economics analyses are ‘normative’. This is economics jargon meaning that they
try to prescribe what people should do. In fact, what payers do correlates poorly with
health economics analyses. In order to predict what payers will do we need descriptive

ASSESSING THE PHARMACEUTICAL PRICE MODELLING TOOLS
models based on a statistical analysis of actual payer behaviour, as described in the
previous section. To make this idea concrete – health economics analyses usually take
the form of an average effect per unit of benefit (e.g. the cost per life-year saved). This
takes no account of the number of patients that the product treats – a factor that, as
discussed above, is very important. (In fact, it is possible to make health economics
analyses more descriptive and therefore to predict behaviour more accurately. But this
involves breaking the ‘rules’ that have grown up around health economics.)
In summary
In summary, there are many pricing techniques that can be used to determine the
response of the market to a product. These can be grouped into three main types, as
summarised in Table 4.1.
Two important principles have been encountered repeatedly throughout the description
of these tool types. First, combine the results from different techniques for greater
accuracy; and, second, prefer simple techniques, as they are just as accurate as well as
being cheaper and easier to understand.
Table 4.1 Summary of techniques used to determine market
response to a product’s proposed price
Surveys
There are two broad types of technique: non-trade-off and trade-off. The former
overestimates price sensitivity and the latter underestimates price sensitivity. The best
solution is to use both and combine the results
Econometrics
These can provide pricing insights where surveys find it difficult to probe (e.g. payers’
price sensitivity) and can improve the accuracy of survey techniques alone
Health economics
These are more price-advocacy tools than price-setting tools. This is because they
prescribe how people should behave rather than describe how they actually behave
Source: Inpharmation
About the author
Gary Johnson has provided price modelling and consulting to most of the world’s leading
pharmaceutical companies. Prior to founding Inpharmation he held senior positions –
including General Manager and Head of Global Product Marketing – for major
pharmaceutical companies. He is the recipient of a number of prominent awards for
market research and business writing. Inpharmation Ltd, Long Meadow, Spurgrove
Lane, Frieth, Henley-on-Thames RG9 6NU, UK. Tel: +44 (0)1494 883458; Fax: +44
(0)1494 882758.

CHAPTER 5
Managing price throughout the life cycle of a pharmaceutical
product: tools, timing and strategies
Judith D. Bentkover, Marc R. Larochelle and Patricia M. Russell, Innovative
Health Solutions, Brookline, MA (US)
Article summary
This article discusses the management of a product’s price throughout its life
cycle in the context of the complex global environment. An overview of key
analytical tools is provided, along with a discussion of when they should be
used. Material is divided into three life-cycle phases: R&D, pre-launch and post-
launch.
Keywords
Launch, Life Cycle, Price, Therapy Economics
STRATEGICALLY MANAGING PRICE over the entire life cycle of a pharmaceutical
product is essential for manufacturers to remain competitive and financially stable in
today’s rapidly changing market. With the explosion in healthcare spending, cost-
containment measures are being enacted globally, necessitating that manufacturers
demonstrate and justify the value of their products with respect to alternative therapies.
Cost-containment measures vary drastically from market to market, and the continued
increase in cross-border considerations such as reference pricing and parallel trade have
made the pricing function quite complex and challenging.
The unique nature of the pharmaceutical industry requires a value-based pricing system.
On average it takes 10–15 years and US$802m for each new drug developed (Tufts,
2001). Only 5 out of 5,000 compounds tested make it to human testing, with only one of
those five reaching the market (PhRMA, 2001). With the need to amortise R&D costs
over the few products that make it to market, unit prices are often high relative to unit
production costs. A recent analysis comparing gross margins with R&D spending has
identified a close correlation between the two over the past 40 years (Scherer, 2001).
Increases in cost-containment measures are expected to result in decreases in
pharmaceutical profitability. Thus, R&D spending can be expected to decrease,
jeopardising the development of new medicines. Despite these studies, cost-containment
measures continue to be enacted, forcing manufacturers to justify prices by
demonstrating the value of their products.
Pricing in early R&D phases
The need for realistic price estimates of pharmaceutical products during the early stages
of R&D is essential: estimates of the product’s true market potential and appropriate
revenue projections are key determinants of research go/no-go decisions and project

prioritisation. The challenge lies in determining an appropriate level of resources to
allocate to pricing analysis for products at an early stage of development, with
uncertainty of whether or not they will make it to market. Furthermore, the product’s
efficacy and safety are still being tested and are largely unknown, or at best are based on
animal experience which may or may not be applicable to humans. These factors are
key determinants of the value and hence final price of the product, contributing to the
difficulty in developing early-stage price estimates.
Faced with these challenges, an appropriate approach to attaining early-stage price
estimates is benchmarking versus existing therapies, including both pharmaceutical and
non-pharmaceutical treatment interventions for the target disease area. A price estimate
founded on comparisons with existing therapies provides a solid basis for identifying
the current market perceptions of value within the therapeutic area.
If the pharmaceutical under evaluation is a me-too product with expected efficacy and
safety comparable to a pharmaceutical already on the market, identifying the
appropriate comparator and price point is relatively straightforward. The situation
becomes more complex for first-in-class products and products with non-
pharmaceutical treatment options such as surgery. What should be the basis for the price
comparison?
An effective comparison of existing therapies will examine not only product acquisition
costs, but also consider the total cost of care with different treatment interventions.
Therapy economics1
analyses are an effective tool to identify the value of a product in
this context. The use of therapy economics analyses has become quite widespread in the
late stages of R&D and following launch, though given the needed resources and the
challenges associated with lack of available data there is little use for this body of
techniques in the early stages of R&D. Recognising these limitations, the tools and
techniques of therapy economics can still be valuable in the early stages of R&D in
order to set price. The goal of such applications is not to conduct an academically
rigorous, publishable analysis, but rather to obtain market insights and assist in
identifying early-stage price estimates.
Let us consider a company developing a new treatment for urinary incontinence. There
are several interventions already on the market, including pharmaceuticals, surgical
interventions and physiotherapy. An analysis is conducted from the payer’s perspective
to evaluate annualised expenditures for each intervention. Through a small number of
discussions with payers and treating physicians, estimates of the resources utilised and
the associated costs for three commonly used treatment interventions are identified (see
Table 5.1).
1
Therapy economics analyses support products by providing information about the use of
specific products in the context of overall healthcare system costs and outcomes. Moving beyond
the price of the drug, therapy economics analyses translate the efficacy and safety advantages of a
therapy into savings or cost-effectiveness ratios. For example, use of a more expensive drug may
ultimately result in savings from reduced hospital stay or reduction in adverse events.
Traditionally, manufacturers have employed therapy economics near the time of launch to support
pricing and reimbursement; however, the techniques can also prove useful in earlier stages of
development to estimate prices.

MANAGING PRICE IN THE LIFE CYCLE
Table 5.1 Annualised costs of existing urinary incontinence
interventions (€)a
Treatment A
(pharmaceutical)
Treatment B
(physiotherapy)
Treatment C
(surgical)
Drug acquisition 7 0 000
Tests/diagnostics 2 200 20000
Physician visits 1 4 200 00 00
Surgical procedures 0 0 1,550
Total 1,000 600 1,950
a
Values are not intended to be reflective of actual treatments and are included for illustrative
purposes only.
Source: IHS
At this stage in development, the company is unsure how many physician visits and
diagnostic tests will be required with the new treatment, and has identified a range of one
to three visits with a diagnostic workup at each visit as a realistic range of possibilities.
Based on the research conducted with existing therapies, an estimate of €300 per visit
(including the diagnostics) is used along with a range of annualised price estimates for the
new product for comparison with existing therapies (see Table 5.2). This analysis quickly
demonstrates that if the number of visits per year can be kept to one, drug acquisition costs
could be as high as €1,500 and not exceed the total costs of Treatment C, a treatment
currently utilised and paid for. However, in order to be less than Treatment A (a
pharmaceutical intervention), the drug acquisition costs would need to be lower than €750.
This analysis was successful in quickly identifying potential price ranges for a variety of
scenarios that would be valuable for planning purposes. The analysis is limited by the lack
of comparative safety and efficacy data; however, the framework can be expanded to
evaluate that potential as data become available. Given the substantial increase in spending
required when moving from phase II to phase III research (see Figure 5.1), an analysis of
this sort may be warranted to assist in making decisions regarding project prioritisation.
Table 5.2 Possible costs of new urinary incontinence interventions
and comparison with existing interventions (€)a
Annualised drug acquisition cost
Visit cost/year
b
250 500 750 1,000 1,250 1,500
300 550 (a) 800 (b) 1,050 (c) 1,300 (c) 1,550 (c) 1,800 (c)
600 850 (b) 1,100 (c) 1,350 (c) 1,600 (c) 1,850 (c) 2,100 (d)
900 1,150 (c) 1,400 (c) 1,650 (c) 1,900 (c) 2,150 (d) 2,400 (d)
(a): Less than Treatments A, B and C.
(b): Less than Treatments A and C; more than Treatment B.
(c): Less than Treatment C; more than Treatments A and B.
(d): More than Treatments A, B and C.
a
Values are not intended to be reflective of actual treatments and are included for illustrative
purposes only.
b
Includes diagnostic tests at time of visit.
Source: IHS

Figure 5.1 Spending and time requirements for pharmaceutical R&D
by phase
0
10
20
30
40
50
Phase
Spending($m)
1
1.2
1.4
1.6
1.8
2
2.2
2.4
2.6
Time(Years)
Spending Time
Pre-clinical Phase I Phase II Phase III
Source: Mathieu/PAREXEL (1997)
Pre-launch pricing
As a product moves through phase III clinical trials, preparations for launch should
begin, including development of a launch pricing and reimbursement strategy. This
strategy should accomplish three main objectives. It should:
1. Identify price targets in each market.
2. Identify in which markets and in what order the product will be launched.
3. Provide materials and information needed to obtain and support pricing and
reimbursement in each market.
A successful launch strategy requires a coordinated set of activities, including therapy
economics analysis, pricing research and analysis and development of pricing and
reimbursement dossiers. None of these activities are distinct, with each being a key
component of a complete strategy. Although situations vary by product, development
and implementation of a launch strategy should begin at least 18–24 months prior to the
expected marketing approval by the FDA (Food and Drug Administration) or EMEA
(European Medicines Evaluation Agency).
Preliminary therapy economics analyses initiated in the early stages of R&D should be
built upon as the safety and efficacy profile of the products is elucidated. Frequently,
phase III studies can be adapted to include therapy economics endpoints such as quality
of life. As these analyses are refined, the value statement for the product should become
clear, with cost-effective price ranges identified.

Identification of local market price targets and launch sequencing are determined by an
analysis of product value in local markets followed by an analysis of cross-border
considerations (including reference pricing and parallel trade – to ascertain target price
levels in each market). Market research with key stakeholders is an effective tool to
evaluate price sensitivity and perception of product value in local markets. Analysis of
launch sequence and cross-border considerations is enhanced by computerised models.
In order to identify local market price targets that will maximise revenues, an estimate
of the price sensitivity in each market is necessary. Primary research with relevant
stakeholders in each market is an effective tool to ascertain this price sensitivity. There
are several stakeholders whose perception of a new product’s value should be
considered, including payers, providers and patients (see Table 5.3). The interview
programme should present a realistic profile for the product, and ascertain the
respondents’ price sensitivity in terms relevant to them. The therapy economics data
should be presented as part of the product’s profile in order to quantify the value of the
product being evaluated.
Once the market research has been conducted, the results should be synthesised and
analysed to identify price-sensitivity curves and optimal prices in each market. A
common issue with completing this analysis is combining the results from multiple
stakeholders. A simple approach is to combine the results utilising a weighted average
based on the relative importance of each stakeholder. An alternative approach is to
attempt to model marketplace decisions. For example, in many instances, the decision
as to which product to use may be strongly influenced by physician recommendation.
For retail pharmaceuticals, the patient may then make a decision based on payer
coverage and co-payment. Developing an algorithm to combine the responses based on
the marketplace decisions may result in a more accurate estimate; however, it should be
noted that this method often requires making assumptions regarding overlap between
the interests of various stakeholders.
Table 5.3 Pricing research stakeholders and key issues to explore
Stakeholder Key issues
Payers
(public or private)
• Healthcare system and level of price regulation
• Perception of product value in terms of safety and efficacy
• Perception of therapy economics argument
• Predicted coverage and utilisation at various price levels
• Budget impact of therapeutic area
• Coverage and utilisation of existing therapies
Providers • Perception of product value in terms of safety and efficacy
• Predicted utilisation at various price levels
• Impact on prescribing budget (where applicable)
• Utilisation of existing therapies
• Coverage and reimbursement of physicians’ services
associated with product
Patients • Perception of product value in terms of safety and efficacy
• Predicted utilisation at various co-payment levels
• Utilisation, adherence and compliance with existing
therapies
Source: IHS

Once optimal local market prices have been identified, an analysis of cross-border
considerations should be considered. This analysis is most relevant in Europe, where
reference pricing and parallel trade are increasingly prevalent. With reference pricing,
country pricing authorities base their pricing decisions on a comparison with the price
of the same product or products in the same therapeutic area in other markets (Urch,
2001). This practice has substantial implications for determining the launch sequence,
as the price in one country has an impact on the price in other countries. Parallel
traders take advantage of price differentials between countries, buying in low-priced
countries and reselling in high-priced countries, resulting in lost revenue to the
manufacturer.
To address these considerations, an analytical model is useful to predict the impact of
the complex set of cross-border issues. Consider an example product to be launched in
Western Europe, with an optimal local market price range from $0.10 to $0.20 per unit.
At these price levels, the product may have substantial exposure to parallel trade. Given
the difficulty in obtaining higher prices in many regulated Western European markets,
one strategy is to institute a floor price.2
This strategy involves the trade-off of reducing
the exposure to parallel trade, while foregoing revenue from low-priced markets. An
analysis of this situation reveals that instituting a floor price of $0.125–0.150 will lead
to a reduction in parallel trade exposure that more than offsets the loss in revenue from
not launching in all markets. As the floor price increases to $0.175, further reductions in
parallel trade exposure fail to offset the loss in revenue associated with not launching in
additional markets (see Figure 5.2).
Figure 5.2 Floor price analysis for example product
$145,000
$150,000
$155,000
$160,000
$165,000
$170,000
$175,000
$1.100 $0.125 $0.150 $0.175 $0.200
Floor price
NPV(000)
0
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1,400,000 Sales(000Units)
European Total Gross Profit NPV (000) European Total Parallel Trade S ales (000 Units)
The assumption is a launch price of $0.20 in the UK and Germany, $0.15 in France and $0.10 in
Spain. Prices in other countries are calculated based on reference pricing relationships.
2
Setting a floor price is a strategy to minimise exposure to parallel trade. The floor price is the
minimum price at which a company will launch a product in any market. Thus, if pricing
authorities in any country will not grant approval at at least the floor price, the product will not be
launched in that market.

Following completion of the analysis of cross-border considerations, the company will
have target price levels for each market. The final step in getting a product launched
will be to complete and submit Pricing and Reimbursement Dossiers in markets as
required. The therapy economics analysis developed and tested as part of the pricing
analysis is a key component of these dossiers. In addition to therapy economics,
standard components include sales forecasts, budget impact projections and production
cost estimates.
Post-launch pricing and strategy
After a pharmaceutical product has been launched, the pricing function should remain
active, adapting and responding to market changes. With the exception of the US,
upward price adjustments are very difficult to attain. Typically, pharmaceutical
companies adjust prices in the US once or twice a year. Upward price adjustments are
acceptable; however, in addition to examining the price sensitivity of customers,
companies must be cognisant of bad publicity associated with raising prices too
quickly.
Throughout Western Europe, government-imposed price decreases are the norm. In
some cases, annual price cuts are to be expected and should be incorporated into launch
price estimates. The UK presents an interesting opportunity with regard to price cuts.
UK pharmaceutical prices are indirectly controlled by the Pharmaceutical Price
Regulation Scheme (PPRS), which limit profits to a certain return on investment.
Occasionally, an across-the-board price cut will be negotiated with PPRS members. For
companies with more than one product, they have the opportunity to modulate the price
cut across products, selecting one product to be reduced by more or less than others. As
the UK is typically a high-priced market, implications for parallel trade are substantial.
An analytical model can help identify which product in the company’s portfolio would
be best to reduce or, alternatively, maintain price.
Therapy economics analyses completed before launch can be transformed into valuable
marketing tools after launch. In addition to static analyses, computerised models can be
created to transform specific economic studies or a collection of research into a useable
electronic resource, which allows development of customised analyses for each
customer to illustrate specifically the value of the client’s products for that particular
customer.
Finally, conducting new post-marketing or phase IV therapy economics studies is also
valuable, especially where real-world patient compliance and adherence are important
issues. For example, compliance and adherence with preventive asthma medications are
substantial obstacles to maintaining adequate asthma control. Asthma exacerbation
leads to expensive hospital admissions, emergency admissions and higher uses of rescue
therapy. At the time of launch, montelukast, an innovative oral medication, was billed
as likely to achieve improved compliance and adherence, leading to improved outcomes
compared with standard inhaled medications. In order to test this, an evaluation of real-
world data from a primary care database in the UK was performed. The analysis found
that the use of montelukast was associated with a significant reduction in concomitant
drug therapy utilisation and costs, suggesting an improvement in asthma control (Price
et al., 2001).

Table 5.4 Potential strategies to respond to changes in the
competitive landscape
Event Strategy Possible consequence
Innovator drug going
off patent
Hold or raise innovator price
to extract revenues as long
as possible
Lower innovator price to a
level that discourages
generics from entering the
market
Introduce patented drug as
OTC drug prior to patent
expiration
Loss of share to lower-priced
‘me-too’ drugs
May lead to a price war with
generics, thus lowering
overall revenue
Could potentially switch
current customers’ loyalty to
OTC so that company reaps
long-term, low-margin
revenue
Lower priced ‘me-too’
drug is introduced
Hold or raise price of
innovator product to extract
revenues as long as possible
Lower innovator price to ‘me-
too’ level
Possible loss of market share
to newer cheaper drug
This might lead to a
prisoner’s dilemma, resulting
in price wars and revenue
loss
Source: IHS
Conclusion
Successful pricing strategies require constant monitoring, evaluation and adjustment
throughout a drug’s life cycle. Therapy economics is an effective tool, which is
expected to become even more important and instrumental in the pricing function as
cost-containment measures continue to be introduced. Careful analysis and attention to
detail when considering pharmaceutical price levels can substantially improve
performance.
References
Mathieu, M.P. (ed.) (1997) PAREXEL’s Pharmaceutical R&D Statistical Sourcebook
1997. Waltham, MA: PAREXEL International Corporation, p. 39.
Pharmaceutical Research and Manufacturers Association (PhRMA) (2001) Quick Facts.
Available at www.phrma.org/publications/quickfacts/01.03.2001.34.cfm (accessed 28
October 2002.
Price, D.B., Ben-Joseph, R.H. and Zhang, Q. (2001) Changes in asthma drug therapy
costs for patients receiving chronic montelukast therapy in the U.K. Respiratory
Medicine 95(1), 83–89.

Scherer, F.M. (2001) The link between gross profitability and pharmaceutical R&D
spending. Health Affairs 20(5), 216–220.
Tufts Center for the Study of Drug Development (30 November 2001) Tufts Center for
the Study of Drug Development pegs cost of a new prescription medicine at $802
million. Available at http://csdd.tufts.edu/NewsEvents/RecentNews.asp?newsid=6
(accessed 28 October 2002).
Urch (2001) The Guide to European Pharmaceutical Pricing and Reimbursement
Systems. London: Urch Publishing.
About the authors
Judith D. Bentkover, PhD, is the President and CEO of Innovative Health Solutions
Corporation (IHS), a global healthcare consulting firm. She is a consultant to numerous
global bio-pharmaceutical and medical device firms and to several government agencies.
She has more than 20 years’ experience in working with global pharmaceutical pricing.
Formerly a faculty member at Harvard University, she taught health economics and
healthcare policy courses.
Marc R. Larochelle is a Senior Manager at IHS. He is a consultant to bio-pharmaceutical
and medical device firms in Europe and North America. He has designed and
implemented several pricing studies at national and international levels. He has also
developed an electronic Pricing Decision Support Tool designed to assist the
development of global pricing strategies to maintain a premium price and maximise
revenue.
Patricia M. Russell, MBA, is a Consultant with Innovative Health Solutions.
Innovative Health Solutions Corporation, 1330 Beacon St, Suite 316, Brookline, MA
02446, USA. Tel: +1 (617) 303 8777; Web: http://www.ihsolutions.com

CHAPTER 6
The importance of health economics in successfully
achieving a sustainable price for reimbursement
Paul C. Langley, US and International Manager, Health Economics, 3M
Pharmaceuticals & Adjunct Professor College of Pharmacy, University of
Minnesota (US)
Article summary
A pharmaceutical product’s success is due largely to its reimbursement price.
Companies should use their expertise in health economics to justify to
reimbursement authorities the price of a drug. Careful, in-depth assessment of
the marketplace, market segments and reimbursement policy is essential if a
price that is affordable for the authorities, acceptable to the company and
supports customer values is to be achieved.
Keywords
Business Opportunity Assessment, Health Economics, Market Potential, NICE,
PBAC, Reimbursement, US, Viagra
THE SUCCESS OF a reimbursement application is critical to the profitable life cycle of
a pharmaceutical product. While there are a handful of so-called ‘lifestyle’ drugs that
succeed without formulary inclusion, a successful reimbursement application and
formulary positioning is a necessary condition for product success. This comes down to
being able to make a convincing cost-effectiveness and budget-impact case for a
product to the reimbursement gatekeepers in the various market segments within the US
and national health authorities and agencies in other markets.
Indeed, as far as the reimbursement decision is concerned, it has now become
fashionable to describe the need to make a cost-effectiveness case for a pharmaceutical
product or device as the ‘fourth hurdle’. Why? Because it follows the three ‘hurdles’ of
meeting required standards for safety, efficacy and quality which are set by the clinical
regulatory authorities. Economic considerations have now been introduced because of
the cost pressures on health systems and the consequent need for a rational and more
systematic approach to resource allocation. Quite simply, health authorities, insurers
and others responsible for the management of patients are concerned with achieving
value for money. If the fourth ‘hurdle’ fails to contain healthcare costs we will,
presumably, see additional hurdles being put in place.
The formal role of economic analysis as one factor in the drug assessment process can
be traced back to the introduction in Australia of guidelines by the Pharmaceutical
Benefits Advisory Committee in August 1992 (Commonwealth Department of Health,
Housing and Community Services, 1992) and revised in 1995 (Department of Human

Services and Health, 1995). Since then, a number of countries have introduced
formulary submission guidelines, the most recent and noteworthy contribution being
seen in the establishment of the National Institute of Clinical Excellence (NICE) in the
UK in May 1999 and the introduction of the Academy of Managed Care Pharmacy
guidelines in the US in October 2000.
Economic analyses are now an essential step in the process of price justification and
market entry. Without formulary listing and reimbursement, drug products are unlikely
to succeed in the marketplace. Whether this approval takes the form of formulary listing
or a recommendation for or against drug use by a health authority, manufacturers can
survive only if they achieve not just reimbursement, but reimbursement at a price that
yields an acceptable rate of return to the bottom line.
In achieving reimbursement, a trend noted in a number of recent reimbursement
decisions by NICE in the UK has been to recommend utilisation for a narrower
indication than that approved by the regulatory authorities. Recently, NICE has argued
that it is prepared to recommend utilisation only for those subgroups in the potential
treating population for which the drug may be deemed ‘cost effective’. While NICE
denies vigorously that this is rationing, it is clear that this is the intention: access to a
drug is denied if it does not meet the criteria for cost effectiveness. In other markets,
demand can be attenuated by the simple expedient of a tiered co-payment. Tiered co-
payments are now used extensively in the US and are seen as a necessary part of any
cost-containment strategy.
Subgroups are important
The implications for the drug development process and the role of health economics are
profound: drug manufacturers may now find themselves having to identify subgroups in
the prospective treating population for which ‘threshold’ health economics arguments
will have to be applied, or a case made for a preferred co-payment tier position. This
imposes an additional burden in developing targeted patient switching scenarios and in
pricing the product for a range of scenarios. It also has implications for study design.
Typically, pivotal trials have not been designed for subgroup analysis. Attempts to
consider the clinical and consequent health economics case may involve either larger
registration (pivotal phase IIIA) trials or the funding of phase IIIB and IV large-scale
effectiveness trials for those subgroups and using these results to support a
reimbursement decision.
Limiting access to a drug to a particular patient segment (e.g. by restricting
prescribing privileges to specialists in a hospital consulting environment) may be seen
as preferable to the technique of tiered co-payments which may be politically
unacceptable to those countries that have a commitment to equity in healthcare
delivery. From a health economics perspective, however, these two forms of rationing
access have to be modelled quite differently in terms of market impact assessment.
Tiered co-payments require a willingness-to-pay assessment approach, while the
patient segment restriction approach requires a targeted health economics argument to
maximise market share.
Of course, any reimbursement process can be used to deny access to drug therapies. As
there are no absolute criteria (or ‘threshold’ criteria such as cost per quality-adjusted life

HEALTH ECONOMICS AND REIMBURSEMENT
year or QALY) for meeting the cost per unit of outcome or cost-effectiveness hurdle,
the possibility of a ‘fifth’ hurdle of ‘affordability’ emerges. Reimbursement authorities
can easily use the argument that an applicant has failed to make a satisfactory case and
avoid the political fallout from refusing reimbursement or recommending against a drug
therapy by putting the responsibility squarely on the applicant. Many reasons can be
given for denying a favourable decision – failure to provide an active comparator trial
and the choice of an inappropriate comparator being the two most favoured
rationalisations. Even so, if a reimbursement group wishes to deny formulary approval,
there are many ways in which this can be achieved – the clinical merits of a drug may
bear little, if any, relevance to the decision.
The drug manufacturer can hardly be blamed for feeling paranoid. In hiding behind
what they see as arbitrarily imposed evidentiary and analytical standards,
reimbursement authorities appear omnipotent. The ‘appeal to the evidence’ mantra
has a hollow ring when it is seen to justify nothing more than a crude and arbitrary
rationing process – a process where, many would argue, patient needs (e.g. the older
population) take very much a second place to political expediency and budgetary
considerations.
What is the answer to this potentially adversarial relationship? One response is to
attempt to go behind the process to appeal directly to patients and governments. This is
a short-sighted and ultimately fruitless approach. Another is to think strategically and
build into the drug development process a recognition that a defensible unit price is both
a necessary and sufficient condition for market entry and market success. Pricing for
reimbursement success is the key – pricing that reflects an understanding both of the
patterns of treatment and total costs of care as well as the potential budget impact of
drug switching.3
Hence the importance of pricing and budget impact modelling at the
earliest stages of drug development; not an activity that can be left to the last minute,
after favourable phase III clinical results.
Pricing and total cost
The perception of many people, particularly those in the political arena, is that few
manufacturers care about the consequences of drug development and reimbursement
for the viability, in either competitive or political terms, of the healthcare system.
Indeed, the attitude that seems to describe the dialogue between manufacturers and
purchasers is essentially one of unit price justification rather than a more
sophisticated approach that tries to encourage a more positive and long-term
relationship between the two parties in focusing on the total costs of healthcare and
the cost consequences of product entry.
This adversarial approach may be seen in attempts by drug companies to draw a line
between claims for cost effectiveness and the budget impact of new drug products.
Perhaps the best example of this is the Pfizer Pty Ltd v. Birkett case in the Federal
3
It should be emphasised that there is unlikely to be a ‘generic’ cost-effectiveness case that can
be made for a new product across all markets and market segments. Differences in treatment
patterns, and thus the choice of comparator products, together with differences in resource
utilisation and unit direct costs of medical and pharmacy inputs, means that the company must
tailor its reimbursement case to the particular market segment. The key economic activities that
are described here are, therefore, activities that should, in principle, be undertaken in all markets.

Court of Australia. In this case, Pfizer challenged the decision of the Pharmaceutical
Benefits Advisory Committee (PBAC) not to recommend to the Minister for Health
and Aged Care that Viagra (sildenafil) be included in the Pharmaceutical Benefits
Scheme. Without the minister’s declaration the drug remains available on
prescription, but at full price. Pfizer argued that the PBAC’s decision was based on
irrelevant considerations. Chief amongst these was that there was a division of
functions between the PBAC and the minister. As the PBAC comprises mainly
medical and pharmaceutical experts, it is to such issues that its deliberations should
be limited. The PBAC is bound to consider the ‘cost and effectiveness’ of therapies,
but other ‘political’ factors, including the overall cost to the government, are for the
minister to take into account. The ruling of the Federal Court was that the PBAC’s
considerations cannot be restricted in this manner.
In this case the PBAC’s decision, as summarised in the Viagra judgment, are worth
noting as they are very much at the core of the arguments presented here for a well-
thought-through health economics case being a prerequisite for a favourable
reimbursement decision. The reasons, as summarised, are:
1. That the cost to government of subsidising Viagra under the Scheme (PBS) was
likely to be unacceptably high, particularly as there was a risk that the usage of the
drug could not effectively be limited to people for whom it was medically indicated,
namely to people suffering from ‘organic impotence of neurogenic or vasculogenic
origin’.
2. That an alternative preparation, alprostadil (commonly know as Caverject) was
already available under the PBS for treatment of the same condition. Caverject is a
substance which promotes erection when injected at the base of the penis. The
Committee decided that Caverject remained effective and available and appeared to
be meeting the needs of patients for which it was clinically indicated.
3. That in the absence of material enabling direct comparisons to be drawn between
Viagra and Caverject, it had not been established that Viagra was as effective as
Caverject.
Three points are worth noting in respect of this summary. First, budget impacts are a
central concern to the PBAC (as they will be to any health system); second, where there
is an existing product for that indication, if it appears to be meeting the needs of
patients, the case for a new therapy is that more difficult; which leads to the third
consideration that, in the absence of head-to-head trials, we cannot assume that the new
product is as effective as the existing product.
At a more technical level, the fact is that claims for cost effectiveness must define the
underlying cost structure of healthcare delivery. With competing drug therapies, the
underlying cost structure is a function of the number and characteristics of patients who
are being treated with particular therapies (Langley, 1997; Langley and Bhattacharyya,
1997). Unless one is prepared to assume a regime of constant costs per unit of
healthcare outcome, claims for cost effectiveness will depend upon the market share and
characteristics of patients who are switched from an existing to a new therapy. Relative
cost effectiveness will depend upon the extent of patient switching (to include, if a case
can be made, patients seeking therapy who have not sought treatment previously).

Patient switching will drive the budget impact of competing drug therapies. As average
cost effectiveness will depend upon the total cost of treating patients and the number of
patients treated, we cannot draw a dichotomy between the number of patients switched,
claims for average cost effectiveness and the total costs or budget impacts of a new drug
therapy. Hence the importance of a thorough understanding of treatment patterns,
resources utilised and the costs of treating patients in the target disease area in all
important market segments.
Achieving an affordable price
What is an affordable price? It is the unit price for the product that is acceptable both to
the payer and to the drug manufacturer. Rather than a price set in the final stages
following phase III results and regulatory approval for safety and efficacy, an affordable
price is one that the manufacturer believes is consistent with achieving a meaningful
market share and which at the same time does not put unacceptable budgetary pressures
on the payer.
In the traditional analyses of cost effectiveness, the price is taken as given and the
analysis proceeds (typically using average wholesale price) to generate cost–outcome
ratio claims. No account is taken of the anticipated total cost or budget impact of new
drugs and whether budgets are consistent with targets in disease areas – issues that
impinge directly on affordability and the willingness of healthcare systems to list new
products (with a distinction drawn between products that are in a new class and those
that might be seen as ‘me-too’ products within an existing class).
The key to identifying an affordable price is through the business opportunity
assessment (BOA – see boxed feature overleaf). This not only provides the focus for
health economics activities and links these to the epidemiology of the disease state (in
the assessment of market potential) but it also provides the link between the health
economic and clinical parameters of the principal treatment options in that disease
state.
Treatment patterns and costs cannot be considered in isolation from the clinical
performance of comparator products (an understanding of which is critical to
establishing a believable cost-effectiveness case). Pooled estimates of comparator
performance, with an evaluation of the quality of comparator clinical peer-reviewed
studies, are a key input to the expectations held for a new compound and the design of
the appropriate clinical trials; trials which are designed not only to satisfy the regulatory
authorities for marketing approval but the audience of treating physicians and
reimbursers.
In developing a BOA, the objective must be internal consistency. A series of questions
should be asked: are the assumptions made consistent with each other? Is the assumed
unit price consistent with projected market share? Are unit price and market share
consistent with the projected level of advertising and promotional activity? Is unit price
consistent with assumptions as to the rate of market entry? To what extent is market
share dependent upon achieving reimbursement? In short, can we justify our
assumptions – or, at least, provide a framework that lets us identify which assumptions
are the most sensitive in driving cash-flow estimates.

The business opportunity assessment (BOA)
From a manufacturer’s perspective, the identification and timing of health economics
activities to support product development should be seen in the context of initial and
ongoing BOA for the proposed product. A BOA is a spreadsheet model that attempts
to project, over the life cycle of the product, annual cost and revenue streams as the
basis for an evaluation of the rate of return from investing in that product.
The hallmark of an acceptable BOA is transparency both in the links between the
building blocks of the assessment and in the data sources that populate it. In the
former case, care has to be taken in defining terms appropriately (e.g. annual treating
prevalence versus annual treating incidence) and showing how the spreadsheet cells
are linked; in the latter, assumptions have to be justified (e.g. estimates of age-
specific treating prevalence) and fully referenced. Attention to detail in this way
ensures that the business opportunity claims for market potential can be justified and,
if necessary, revalidated. Also, as the BOA is a working document, full documentation
means it can be revised and changes in underlying assumptions documented (e.g.
claims that the existing treatment prevalence in a disease state understates ‘true’
market potential by ignoring those who are not being treated).
There are five steps involved in creating a BOA for a new product. These are:
• identify and project the product life-cycle annual treatment prevalence for a
disease state
• identify and project the current direct costs of treating patients in that disease
state (medical and pharmacy costs)
• identify and project patient switching scenarios over the product life cycle
• project development costs, reimbursement, and sales and advertising costs
• project sales revenues at contract prices.
In developing a BOA it is recommended that, while a spreadsheet model is used, a
simulation approach is taken in representing both input and output variables. The
reason for advocating such an approach is because of the uncertainty that attaches to
many of the key input variables.
The assessment of an affordable price assumes, of course, that the respective
healthcare systems take a total cost perspective in evaluating cost-effectiveness and
budget-impact claims. Unfortunately, most healthcare systems still adopt a silo
budgeting approach. That is, they identify pharmacy and budget expenditures
separately and judge a new product in terms of its impact on the pharmacy budget. In
the US, pharmacy benefit management companies are in the position of being driven
by drug costs and volume contracting with pharmaceutical manufacturers. While they
may pay lip service to the need to balance potential cost-offsets from the medical side
against drug costs, it is difficult to see how much weight they would attach to cost-
offsets in formulary choice. Even so, there are pharmacy benefit management
companies that have adopted formulary submission guidelines that ostensibly take a
total cost approach.

Assessing market potential
A continuing theme in this report is the need in BOAs to eschew a global evaluation in
favour of one that explicitly recognises the impact of market segmentation on the case
that has to be made for a drug and the optimal pricing strategy for a product.
From a global perspective, the first step is to allocate health economics resources by
market; to decide in which countries (and market segments) it is most important to
achieve reimbursement and to detail the reimbursement requirements. In other words, to
decide which health economics activities should be directed to which market in order to
maximise the probability of a successful reimbursement application in that market or
market segment.
One way of visualising how resources might be allocated is to develop an index for
pharmaceutical sales potential. Given that the US is the single most important market
for pharmaceutical products and the most heterogeneous in terms of its health
economics requirements, an index that indicates a country’s position relative to the
US is useful. A proposed index is presented in Table 6.1 overleaf, based upon three
country characteristics: total population; per capita GDP; and percentage of GDP
accounted for by the healthcare sector. Using the US as a baseline (US = 1), values
for each country are expressed for each characteristic relative to the US figure. These
indices are then multiplied together to give an aggregate Sales Potential index (final
column).
The dominant position of the US is readily seen. Japan, the second most important
market, contributes only 0.23 sales potential points. This is followed by Germany,
which in population terms is the third largest market, scoring only 0.15 points – the
US market in pharmaceutical sales potential, given its higher GDP per capita and a
higher proportion of GDP devoted to healthcare, is over six (almost seven) times as
important. France is the next most important market (but only one-tenth the size of
the US) with the UK (far behind) in fifth place.
The importance of the US market
In terms of allocating resources to health economics activities, if these are to be spent in
proportion to the sales potential, the US is by far the single most important market.
Given the returns to scale that would follow from establishing a core health economics
case in the US, returns per dollar invested are substantially greater. Also, the US is not
necessarily the most sophisticated market for health economics arguments. In terms of
guidelines development and evidentiary standards required Australia (PBAC) and the
UK (NICE) share that honour, as both these countries have national guidelines and the
expertise readily available to assess submissions.
For most drug companies (and virtually all biotechnology companies), the health
economics case should first be made for the most important market of all, the US. The
US is not only the most important market in dollar terms and one which has the most
permissive pricing environment, but success in the US market allows drug companies
to accept a lower (i.e. subsidised) rate of return in other key markets.

Table 6.1 Relative market potential for pharmaceutical sales
Country
Pop.
(million)
Pop.
index
GDP
per
capita
($)
GDP per
capita
index
Health-
care
GDP
(%)
Health-
care GDP
index
Sales
Potential
index
US 280.0 1.00 37,900 1.00 13.3 1.00 1.00
Japan 127.8 0.46 38,000 1.00 6.8 0.51 0.23
Germany 82.8 0.30 27,100 0.72 9.1 0.68 0.15
France 60.0 0.21 25,900 0.68 9.1 0.68 0.10
UK 59.6 0.21 25,900 0.68 6.6 0.50 0.07
Italy 57.9 0.21 21,800 0.58 8.3 0.62 0.08
Spain 39.6 0.14 16,500 0.44 6.5 0.49 0.03
Argentina 37.5 0.13 8,000 0.21 2.5 0.19 0.01
Canada 31.1 0.11 24,400 0.64 9.9 0.74 0.05
Australia 19.4 0.07 22,900 0.60 8.6 0.65 0.03
Netherlands 15.9 0.06 26,900 0.71 8.7 0.65 0.03
Belgium 10.3 0.04 25,700 0.68 8.1 0.61 0.02
Sweden 8.9 0.03 31,000 0.82 8.8 0.66 0.02
Austria 8.2 0.03 22,900 0.60 8.5 0.64 0.01
Switzerland 7.3 0.02 39,400 1.04 8.0 0.60 0.01
Denmark 5.4 0.02 34,800 0.92 7.0 0.52 0.01
Finland 5.2 0.02 28,100 0.74 8.9 0.67 0.01
Norway 4.5 0.02 39,400 1.04 8.4 0.63 0.01
US = baseline.
Source: Author
The importance of the US market for product success means that health economics
activities, particularly those associated with the drug development process, should focus
on the potential offered by the US market. If a product is not expected to meet break-
even rate-of-return projections for the US market, the potential for success in other
markets such as Japan, Germany, France or Italy is unlikely, individually or
collectively, to take up the slack.
Importantly, and unlike the clinical development process, health economics activities
have to address the needs of both the principal world markets for the drug (in particular
the US) and key market segments within each of these markets. Indeed, from a health
economics and a clinical perspective, it is obvious that there is no such thing as a
‘world’ market for any drug product. Just as the US market is actually highly
fragmented from both clinical and health economics perspectives, so the world market
is also fragmented – both in terms of national units for reimbursement as well as by
treatment segments and the potential for patient switching within those markets. This is
the challenge for health economics: to support product development, market entry and
patient switching in a markedly heterogeneous environment and to be able to
accommodate this characteristic in drug development and market entry decisions.
While Table 6.1 illustrates the absolute importance of the US market to achieving an
acceptable rate of return for any drug product, the relative importance of markets such

as Japan and Germany may belie their potential contribution to the anticipated product
sales profile, making it important to evaluate and prioritise markets and market
segments within specific disease areas. This involves two crucial steps: (i)
understanding the annual treating prevalence of a disease state for individual markets
and market segments and (ii) identifying the distribution of annual expenditures for
patients for that disease state. Combining these two elements, most appropriately (given
the uncertainties involved and the distributional characteristics of pharmacy and medical
expenditures across patient groups) within a simulation modelling framework, will
generate likelihood estimates of current treating market size in terms of both patient
numbers and treatment expenditures. These elements are critical not only as a first step
in prioritising potential market opportunities but in setting the stage for a first cut at a
business opportunity assessment.
Combining estimates of annual treating prevalence with treatment expenditure
distributions allows us to address the issue of levels of reimbursement and the extent to
which there is a trade-off in market prioritisation between a relatively high level of
treating prevalence, driven by the population size of the national market or market
segment, and the level at which providers are reimbursed or capped for medical and
pharmacy services. Germany, for example, while having a population base which is
substantially greater than the other major European markets, has a relatively low level
of reimbursement for medical and pharmacy services under the public insurance scheme
and the silo-based contractual arrangements that insurers have with providers. A further
example would be the Medicare market segment in the US, where a substantial
proportion of Medicare-eligible patients have no pharmacy coverage. While
pharmaceuticals are covered if administered in a physician’s office (e.g. injectables),
those obtained through a community pharmacy are not covered. They are also provided
(as they are to Medicaid recipients) at public-sector prices. This creates a well-defined
market segment and one where there is a clear trade-off in market prioritisation between
the numbers of patients potentially being treated (high treatment prevalence) and the
ability to capture pharmaceutical outlays (relatively low prices).
Winning the health economics case
How do drug manufacturers ‘win’ the health economics case? The simplest answer is to
become experts, not only in the clinical aspects of drug design and response, but in
understanding, from a resource utilisation and cost perspective, how care is delivered
and the potential for a new product in a given treating environment. This is not
something that can be determined and driven simply with results from highly
aggregated randomised clinical trials – and supported by one or two peer-reviewed
papers arguing for product ‘cost effectiveness’. Manufacturers must understand their
customers and their customers’ needs. They must also understand the evidentiary and
analytical standards set by reimbursement authorities and the constraints that prescribers
may have in switching patients. These are activities that start at pre-phase I and that
extend throughout the life cycle of the product.
The acceptability of a unit price is not the only concern in building a business
opportunity assessment. With increasing cost pressures on health systems and the
authorities increasingly being forced to introduce ad hoc rationing of healthcare, anyone
proposing to bring a drug to market, or proposing to enter into a joint-venture marketing
agreement, should take account of the anticipated budget impact of a new drug. This is

not just a question of price or arguing for a ‘cost-effectiveness’ trade-off between unit
price and clinical characteristics; nor is it a question of claiming a trade-off between unit
price and increased quality of life. Health systems are becoming increasingly hard-
nosed. What they are looking to, first and foremost, is the anticipated budget impact of a
new drug. Drug manufacturers, in seeking formulary listing and reimbursement, are
being asked to justify acceptance in terms of budget impact. The key word is
‘affordability’. Indeed, it almost seems that in reading justifications for rejecting a drug,
bodies such as NICE in the UK equate the term ‘cost effective’ with affordability.
From a healthcare systems perspective, the contribution of a new drug will often be seen
in terms of population risk management. The system-wide impact perspective weights
the clinical contribution of a new therapy for the target or indicated population against
its budget impact. If a drug manufacturer, at the price sought for the product, cannot
justify budget impact claims, then healthcare systems will refuse listing and
reimbursement – or they will list and set restrictions on use or co-payment levels which
effectively eliminate a profitable market share for the drug manufacturer. From the
manufacturer’s perspective the question is whether these risks can be minimised
through an appropriate pricing strategy – a pricing strategy that is driven by a thorough
understanding, in health economics terms, of the place of the proposed product in
therapy.
Although the reimbursement decision is only one element in the process of applying
health economics analyses in drug development, it is the element that has received the
most attention and is the one on which most drug manufacturers focus their health
economics resources. While the reimbursement decision can be critical to marketing
success, it should be seen as the culmination of years of commitment to health
economics in the drug development process. It should also be seen as the first step
towards using health economics activities to support market entry and optimise market
share at a price that guarantees an acceptable rate of return.
References
Commonwealth Department of Health, Housing and Community Services (1992)
Guidelines for the Pharmaceutical Industry on the Preparation of Submissions to the
Pharmaceutical Benefits Advisory Committee. Canberra: AGPS.
Department of Human Services and Health (1995) Guidelines for the Pharmaceutical
Industry on the Preparation of Submissions to the Pharmaceutical Benefits Advisory
Committee (Including Major Submissions Involving Economic Analysis). Canberra:
AGPS, pp. 93–98.
Langley, P.C. (1997) Pharmacoeconomics: achieving gold standards. London:
Financial Times Healthcare.
Langley, P.C. and Bhattacharyya, S.K. (1997) Treatment costs, equilibrium and the
allocation of patients between therapy alternatives. Clinical Therapeutics 19(1), 830–
836.
National Institute for Clinical Excellence (NICE) (June 2001) Guidance for
Manufacturers and Sponsors (No. 5 Technology Appraisal Series). London: NICE.

About the author
Paul Langley, PhD, is US and International Manager, Health Economics, with 3M
Pharmaceuticals, St Paul, Minnesota, USA. He is also Adjunct Professor, College of
Pharmacy, University of Minnesota.
Dr Langley received his undergraduate training in the UK and his postgraduate training
in Canada, with a PhD in Economics from Queen’s University. Following graduation, he
taught at universities in Canada, the UK, Australia and the US. He moved to the US in
1994 and taught at the University of Arizona and then the University of Colorado where
he was Professor in the School of Pharmacy, University of Colorado Health Sciences
Center, Denver. He joined 3M Pharmaceuticals in September 1999.
In his position at 3M Pharmaceuticals he has overall and worldwide responsibility for
pharmacoeconomic evaluations in the Pharmaceuticals Division. This includes
supporting product development through health economics studies, preparing
preliminary reimbursement submissions, managing reimbursement applications (e.g. the
US, the UK, France, Italy), pricing evaluations and post-market-entry
pharmacoeconomics support. These last activities include both evaluations to maintain
product reimbursement in the principal markets for 3M products and ongoing research
and marketing programmes to monitor market share and the appropriate use of products
within healthcare systems.
Dr Langley can be contacted at 3M Pharmaceuticals, 3M Center, Building 275-3W-01, St
Paul, MN 55144-1000, USA. Tel: +1 (651) 733-3153; email: pclangley@mmm.com)

CHAPTER 7
Hospital negotiation – the use of health economics as a
support for new product pricing
Brian Lovatt, Pharmaceutical Health Economist and Policy Analyst (UK)
Article summary
Healthcare systems in the Western world are under pressure to deliver high-
quality services to an ever-demanding population. Several factors add to this
growing pressure, including innovation in medical equipment and
pharmaceuticals. This article considers this problem from the perspective of the
hospital purchasers and the pharmaceutical budget, and the health economics
methodologies that are used to assess products.
Keywords
Cost Benefit Analysis (CBA), Cost Consequence Analysis (CCA), Cost
Effectiveness Analysis (CEA), Cost Minimisation Analysis (CMA), Cost Utility
Analysis (CUA), Formulary, Health Economics, Hospital, Quality of Benefit
THE RESEARCH-BASED pharmaceutical industry faces a significant difficulty in
matching its ethical duties: to research and produce treatments and supply them to the
many sufferers across the globe and please its shareholders with an appropriate return
on investment in order to continue to provide new treatment opportunities. This
difficulty is compounded by the inflation in R&D costs – currently estimated at
approximately US$850m – to bring a new drug successfully to market, an amount that
is growing at a rate of about US$500,000 per month!
Research costs are rising for a combination of reasons, including increasing regulatory
demands, larger clinical trials with more populations being tested, and expensive
investment in technology. Attrition rates are another major cost factor that hopefully
will, in the near future, be lowered by new software simulation techniques. It takes up to
100,000 potential new products in the laboratories to produce one that eventually
reaches the market – a sobering statistic.
The result of such high R&D costs is that new pharmaceutical products need to be
commercialised across a wide geographical area to provide a return on their investment
and have to be priced at a level to provide sufficient money to fund new research.
Research-based pharmaceutical companies therefore have to produce a persuasive
proposition to formulary committees that the price of a new product has added value in
terms of safety and efficacy and that the cost per case represents a worthwhile
investment.

Cost-containment programmes
Cost-containment programmes have been set up in most healthcare markets as barriers
to the entry of technology that cannot define its value and specifically demonstrate that
it offers a better outcome than the current alternatives. These barriers exist at several
levels. In many countries the pricing and reimbursement committees are the first to
challenge the price, then purchasing committees at a regional level, and finally hospital
formulary groups which need to manage their local budgets and address the specific
needs of their patient populations.
Hospital formulary groups
Hospital pharmaceutical purchasing committees and formulary groups need to be able
to demonstrate that they discharge their responsibility in providing a service of selecting
the products that offer the best overall ‘value for money’. Some use ‘value in use’ as an
alternative measure, but in reality they are the same goals.
To enable them to fulfil their role they need methodologies that can rate the value for
money of each of the alternatives that can be used to deliver a known quantity and
quality of care. Health economics is the tool they have come to use.
In essence, health economics is a methodology that is applied to identify all the costs
and consequences that result from using a new product in the treatment of a defined
patient population, compared with all the costs and consequences of an alternative
treatment plan or plans.
Health economics methodologies
Health economics has a variety of different methodological approaches to produce
the relevant arguments. For example, if two products have almost the same benefits
and related costs then one can simply assume that the lower priced product is the
most cost effective. This is often called cost minimisation analysis (CMA) or cost
analysis.
However, in almost all cases the product profiles will differ and therefore the safety and
efficacy impacts differ. In this case it is important to identify all the areas of difference
in a comparative way, controlled to avoid bias. These differences in outcome are
analysed along with any differences in the resources required to produce them. This
methodology is called cost effectiveness analysis (CEA) and is the most common
methodology applied at present.
One of the difficulties encountered is that the modern pharmaceutical profile will often
produce a gentler overlay either of positive effects, such as a feeling of well-being, or
negative effects, such as nausea, drowsiness and other factors often described as
impacting distress or discomfort. In addition, some older products had a relative
disability factor associated with them, where the effect was so significant that it was
impossible to carry out normal activities. These three ‘D’ factors (discomfort, distress,
disability) are very important to patients and their carers, though the three ‘Ds’ are often
very difficult to measure in a meaningful way.

HOSPITAL NEGOTIATION
Table 7.1 Definitions of health economics methodology
Cost minimisation analysis (CMA)
Used to compare the costs of two or more programmes that achieve the same
outcome
Cost effectiveness analysis (CEA)
Compares different programmes producing the same type of benefit (non-monetary)
in relation to their monetary costs to provide an assessment of efficacy
Cost consequence analysis (CCA)
Created by Professor Martin Buxton to allow the analysis of outcomes where there is
no accepted or valid method of valuing the benefits. This is achieved by describing the
outcomes in a textual format
Cost utility analysis (CUA)
Relates a project’s costs to a measure of its usefulness or outcome, called a utility
measure
Cost benefit analysis (CBA)
Assigns a monetary value to the benefits of a given healthcare programme, and
makes a comparison with the monetary costs involved in providing that programme to
deliver an assessment of efficiency
Source: Author
Measuring quality of care
Even when appropriate measures exist it can be very difficult to incorporate the total
resultant effects into an analysis. The conversion of a missed night’s sleep into a dollar
value would be ideal, but it is almost certain that if a hundred people were asked to
provide an estimate each would give a different valuation.
Assuming that one can value some of these health-related quality-of-life factors, if the
hospital does not have to ‘pay’ for them directly then it does not see any direct
displacement of costs, so one can argue that they do not directly affect the decision. So
why bother? Not to bother would admit that an improvement in the patient outcome is
only an external issue, and not part of the role of healthcare providers. Would one agree
to have a dental extraction without a local anaesthetic?
Research will need to continue to explore methodological approaches to better define
the value of these factors. Hopefully one day we will be able to compute what the dollar
value of a pain-free day is worth or a sedative-free effect, without dispute. Beyond that
we have to look at the value of adding extra time to a patient’s life, hopefully at an
acceptable quality.
Measuring quality of benefit
Once the added time and value provided by medical interventions are reviewed the
whole question of what a life is worth becomes important. The current approach is to
define what an acceptable and appropriate outcome would be, and then present the
comparative analyses opposite these outcomes. Therefore, the comparative cost of
achieving a pain-free day or producing an extra month of life is determined, and, when
quality is measured, the impact is determined by using an equivalent of a dead (0) and
healthy (1) scale system, and the extra days are adjusted by the relevant factors.

Table 7.2 Health economics methodologies used in the
pharmaceutical sector
Methodology
Measurement of
benefit/outcome Focus
Cost minimisation analysis
(CMA)
Equivalence demonstrated
in comparative groups
Efficiency
Cost effectiveness
analysis (CEA)
Single outcome in
comparative products
(‘natural’ units) (e.g.
millimetres of mercury or
life years gained)
The least costly way of
achieving the chosen
outcome or health benefit
Cost consequence
analysis (CCA)
Descriptive
benefits/outcomes where
measurement is not
possible or practical
The cost(s) of providing
the described benefits
Cost utility analysis (CUA) Natural units adjusted for
quality (e.g. quality-
adjusted life years gained)
Describing both the costs
and outcomes including
the quality of the health
benefits
Cost benefit analysis
(CBA)
Monetary value of multiple
benefits and outcomes
The best investment of
limited resources
Source: Author
For example, if a patient has an extra 100 days at a quality of life that they rate as being
half way on the appropriate rating scale, then each day would be worth only 0.5. If the
comparative treatment regimen delivered the same 100 days at, say, 0.7 then there is the
possibility of stating that the treatments are X cost per either 50 or 70 quality-adjusted
days. This is only a descriptive example to demonstrate the concept, as this
methodology is often applied to produce disability-adjusted days or other metrics.
Quality-adjusted life years (QALYs) are a common measure in the literature.
Types of costs
Not all the costs that are analysed are included under the same headings, as they are
borne by different constituencies.
DIRECT: these costs are represented by such elements as physicians’, nurses’ and other
healthcare workers’ time, supplies, medicines, overheads such as heating and lighting,
and an element for the capital costs. These costs are those that are most often the focus
of attention of hospital providers and formulary committees. Additionally, if the patient
makes a financial contribution to treatment this is categorised as a direct cost.
INDIRECT: these costs include, for example, time lost from work, the cost of paying
for childcare whilst unable to look after children because of treatment-related effects,
and so on.
INTANGIBLE: these costs are often very challenging to assign a monetary cost to
because they represent areas of distress, disability and discomfort.

Figure 7.1 The measurement of economic costs and benefits in
healthcare research
Target
Patient
Population
Treatment
Approach A
Treatment
Approach B
Impact on Resource Use
Impact on Health Status
Impact on Health Status
Impact on Resource Use
Direct costs
Hospitalisation
Tests and procedures
Medication etc.
Indirect costs
Time off work etc.
Quality of life
Survival
Direct costs
Hospitalisation
Tests and procedures
Medication etc.
Indirect costs
Time off work etc.
Quality of life
Survival
Source: Author
Types of benefits
The same broad three headings apply to benefits. Direct benefits could include, for
example, reduction in the time spent in hospital or the switch to out-patient rather than
in-patient care. Indirect benefits could include early return to work. And, finally,
intangible benefits could include less impact by the treatment (e.g. no nausea and
vomiting).
Important terms and issues
COMPARATIVE: it is important to understand that in an economic analysis all the
costs and benefits are comparative to one or more treatment or care programmes.
INCREMENTAL ANALYSIS: owing to the nature of healthcare provision, there will
always be a comparative way of ‘managing’ patients, even with a ‘do nothing’
approach. Therefore, it is the incremental costs and incremental health improvements
(benefits) that should be the focus of healthcare decision makers.
QUALITY ISSUES: the problem often encountered in dealing with budget-capped
systems is that of gaining the additional value for those elements relating to the quality
of the health outcome caused by, or averted by, the comparative health programmes or
treatments.
Unfortunately, the situation rarely or never exists where everything in a comparative
evaluation is equal, and option A has the same type but better quality outcome than B,
which would enable decisions to favour A. The more usual situation is more complex,
with differential types of outcomes and levels of quality. This is further complicated by
the metrics and measures used.

TRANSPARENCY: experience in dealing with hospital decision makers in a great
many countries has clearly shown that the more transparent the process of evaluation
the better. The need to disaggregate the data in the analyses to show the basis of the
evaluation and all the statistics and natural units used often pays great dividends.
FOCUSED ANALYSIS: it is critical to the success of any presented analysis that it
looks at the comparative costs and consequences of the alternatives that are relevant to,
and use the perspective of (in this case), the hospital decision maker. This simple fact
relates to the area in which the vast majority of analyses fail to inform and are often
completely dismissed and/or omitted from the decision process.
NATURALISTIC RESEARCH: the problem with most health economics analyses is
that they are not ‘naturalistic’ studies but are often based upon clinical trial data.
Clinical trial populations are atypical. The intended patient population is normally
selected to a degree, by applying inclusion and exclusion criteria, in order to produce a
more homogeneous population to study. More tests are carried out and more detailed
reviews undertaken to study the patients and their condition, and therefore management
is more intensive than in the normal environment. Naturalistic studies, in contrast,
attempt to describe the natural, unmanipulated social settings using less intrusive, often
qualitative, methods of collecting the required data.
Summary
In a world where innovation is increasing dramatically and healthcare costs are
spiralling out of control, it is important that both the suppliers and purchasers of
healthcare have a common toolbox to communicate the value for money and value in
practice of the alternatives they consider.
The time has come when me-too products will need to be reconsidered in
pharmaceutical development. Significant improvements in treatment will be essential to
give companies a better product adoption and price/reimbursement and, therefore, a
greater time to recoup the costs of R&D. In addition, product profiles will need to be
tailored to address real areas of need, if they are to be rewarded with market access and
an appropriate price.
Sales people will need to become far more sophisticated in terms of preparing valid and
bespoke presentations to hospital review committees. Indeed, their level of knowledge
of the customers’ patient types and numbers, and their understanding of the process of
care and benefit measures that the hospitals use, will need to be very high for them to
succeed.
Academic analysis with a societal perspective has a place, not, however, in the area of
hospital decision making but in methodological development.
A salutary note is that a new product evaluation for listing on a hospital formulary is
often a one-off event. If a second chance does arise it may be a year later.
In addition, as competitors enter the market or treatment programmes differ, and/or
prices change, it is important for companies to be able to re-analyse and represent their
‘argument’ or risk displacement from the formulary. This will be significant, as to get

back onto a formulary can take up to a year or more and will be more difficult the
second time round.
In conclusion, health economics is here to stay. Much more development of the
methodology is necessary, and the success of pharmaceutical companies will be highly
dependent upon their ability to describe the benefits of their products clearly and in a
meaningful way, and be prepared to keep that information updated as it is relevant to the
life cycle of the product. Hospital formulary committees need to become more familiar
with the methodology of economic analysis, and be able to supply companies and their
analysts with real-life cost data, and share information on current programmes of care.
Only then will the analyses be valuable.
Reference
Should readers want to study pharmacoeconomics in more depth they should refer to:
Bootman, J.L., Townsend, R.J. and McGham, W.F. (1996) Principles of
Pharmacoeconomics. Harvey Whitney Books Company (ISBN 0-929375-17-3).
About the author
Brian Lovatt spent 25 years in the pharmaceutical industry across Research,
Development and Marketing departments. In the early 1990s he studied healthcare
economics and became the first international pharmaceutical industry economist,
developing a clinical trial methodology to address the ‘new’ market challenges. He then
set up a private practice, Vision Healthcare Consultancy, to assist the pharmaceutical,
nutraceutical, biotechnology and other healthcare-related industries to produce and
present health economics data and pricing analyses to the purchasers and providers of
care.
Brian can be contacted via his UK office on: Tel: +44 (0)1883 330334; Fax: +44 (0)1883
330056; email: brianlovatt.vision@btinternet.com

CHAPTER 8
The global AIDS crisis and drug pricing controversy
Faiz Kermani, Budgets, Proposals and Marketing Executive, Chiltern
International (UK)
Article summary
AIDS is the greatest health crisis of modern times. Although pharmaceutical
companies have discovered treatments in a relatively short time, the prices of
these drugs are beyond many in the developing world. This article reviews the
controversial stance of the manufacturers that have argued against price
reductions in the face of political and public pressure. Some countries have
ignored WTO rules and are sourcing AIDS drugs from generics’ manufacturers.
However, things might change with the global fund to fight the epidemic.
Keywords
AIDS, Anthrax, Brazil, Cipro, Doha, HIV, South Africa, TRIPS, UN, WTO
THE AIDS EPIDEMIC represents one of the gravest health crises in modern times.
Over 40 million people worldwide suffer from HIV or AIDS, and each day about
14,000 people become infected with HIV. However, the high rates of HIV infection
seen in the industrialised world have been dwarfed by the scale of the epidemic in the
developing world.
When AIDS first came to prominence in the 1980s there was little available in the way
of treatments. The pharmaceutical industry was quick to react to the crisis and it poured
millions of dollars into R&D for AIDS. With such a huge demand for treatments, AIDS
represented a new and growing therapeutic market. The research successes of the
pharmaceutical industry are highlighted by the fact that there are now over 50
treatments available for HIV infection and about 100 potential drugs and vaccines at
various stages of the drug development process.
As a result of demands from patients, AIDS became one of the most high-profile areas
for healthcare. By 1998, anti-HIV drugs were accounting for up to 30–40% of the
pharmaceutical budgets of many European university hospitals. AIDS activists became
one of the most outspoken patient groups and have continued to have an influence over
how governments and the pharmaceutical industry react to AIDS as a healthcare issue.
From a medical point of view, the progress in the treatment of HIV infection in
industrialised countries has been considerable. In just over 15 years since initial public
awareness, AIDS has evolved from a fatal illness into a chronic incurable disease.
However, the situation is very different in the developing world and the unequal access
to these new therapies has become a contentious issue.

This inequality is highlighted by the situation in Africa. For example, in Western
countries, 500,000 people are being treated for HIV infection and in 2001 there were
25,000 deaths from AIDS. This is in stark contrast to Africa, where only 30,000 people
are being treated for HIV infection and where AIDS caused over two million deaths in
2001.
High costs become an issue
Recent estimates put the cost of bringing a new drug successfully to market at about
US$800m, and this includes a significant contribution from the costs of all new
chemical entities (NCEs) that fail during the R&D process. The probability of an NCE
in development reaching the market increases with each successive phase of the R&D
process. This has meant that, traditionally, only 10% of NCEs entering development
subsequently reach the market and 60% of the active substances currently in discovery
will not progress to the more advanced stages of development. These high attrition rates
are a continuing challenge for the industry.
In order to recoup the costs incurred during the risky process of drug development,
pharmaceutical companies tend to set the price of a new drug at a high level. Companies
are also granted patents that allow them several years of exclusivity to sell the drug. On
a global basis, these work through the World Trade Organisation’s (WTO) Agreement
on Trade-related Aspects of Intellectual Property Rights (TRIPS). This is unpopular
with many patient groups and activists, who feel that companies are profiting from their
illnesses.
In recent times, the price of AIDS treatments has overshadowed progress on the
scientific front. In particular, whilst those with AIDS in wealthy nations can at least
gain some access to new treatments, they are beyond the affordability of the majority of
sufferers in poorer countries.
Prices too high even in Europe
The arguments surrounding the pricing of anti-AIDS treatments are not new and have
not been confined only to the developing world. The arrival of various new drugs to
combat AIDS during the 1990s led to considerable problems for hospitals in Europe. In
1999, there were some 14 anti-retroviral HIV drugs available, as well as a long list of
products awaiting approval.
Many hospitals were simply unprepared for the costs involved in treating patients with
these expensive therapies and this was exacerbated by there being no consensus among
clinicians regarding combination therapies. Practical and clinical problems surrounding
HIV infection contributed to the overall confusion among hospital managers, who had
the task of evaluating the economic consequences of these treatments. At the time there
were also few published studies to document the efficacy and pharmacoeconomic
impact of the different types of anti-retroviral drugs available.
Many UK hospitals became concerned at their spending on these treatments. In May
1997 several managers of major UK hospitals, finance directors and chief pharmacists
approached the Danish research and analysis company Informedica A/S for help to
determine a strategy for obtaining cheaper prices for anti-retroviral drugs. The initial

THE GLOBAL AIDS CRISIS
analysis focused on the price at which the various hospitals were currently buying these
anti-retroviral drugs.
Informedica’s findings suggested that UK hospital contract prices for HIV therapies
were between 20% and 36% higher than those on the Continent. However,
pharmaceutical manufacturers challenged the validity of the European pricing
information gathered by Informedica. Furthermore, they criticised the pricing
comparisons for being simplistic and for not taking into account the volumes that
hospitals were buying across Europe when such prices were initially negotiated.
Nevertheless, a few of the UK hospitals that believed they were facing intransigent
zero-discount policies from HIV drug manufacturers decided to examine the
controversial step of parallel importing some of their supplies of anti-retroviral drugs
from the rest of Europe.
Parallel importing anti-HIV treatments in Europe
Parallel importation is a risky step to take when negotiating for better prices – and anti-
retroviral drugs were no exception. For a start, the whole area of parallel importation is
an ill-defined and legally complex area. The success of parallel importing
pharmaceuticals depends on a complicated mixture of the pricing level and degree of
pricing freedom in a particular country, the willingness of wholesalers to stock parallel
imports and the willingness of consumers to buy them. Parallel importing can occur
only if there is a sufficiently wide pricing differential between two countries for a drug.
Informedica estimated that the price differential between two countries for anti-
retrovirals needed to be in the region of 25% for parallel importation to be sufficiently
attractive. Therefore, setting up a parallel importation option for the hospitals was a
lengthy process.
Yet as news of parallel importation activity filtered out, many hospitals reported 15–
20% discounts being offered to them for anti-retroviral drugs. Once these discounts had
been agreed on with the mainstream pharmaceutical manufacturers, the hospitals
stopped doing business with parallel importers. Many hospitals had been uneasy about
the lengthy negotiations with parallel importers and had concerns over their ability to
maintain a constant supply of the required drugs. Equally, parallel importers had not
been convinced of the hospitals’ commitment to large-volume contracts, which meant
that negotiations had proceeded slowly.
Shift to the primary sector
Whilst drug pricing is still an issue in Europe, there is less of an impact on hospitals,
with much of the emphasis on AIDS treatment having shifted to the primary sector.
Early intervention and the extended survival of patients result in high treatment costs,
but these are offset somewhat by much lower in-patient costs.
The new AIDS treatments have prolonged patients’ life expectancy, allowing them to
lead a more normal lifestyle and thereby reducing the need for constant close
monitoring by hospitals. Following initial diagnosis of the patient and the establishment
of a suitable treatment regime, follow-up treatment can be taken over by physicians in
out-patient clinics and by local general practitioners. This has had major economic

consequences for industrialised countries as lifetime hospitalisation rates are decreasing
among HIV patients.
Pricing and the developing world
When AIDS first hit developing regions, in particular sub-Saharan Africa, few countries
were able to react to the crisis in a comparable way to those in the West. With no
coordinated health education programmes, no rapid means for HIV testing and very
limited access to new drugs, AIDS had a devastating impact. Africa, in particular,
remains the hardest-hit region, representing about 70% of AIDS cases worldwide.
In the last few years, patient access to new medicines in developing regions has become
a controversial issue and has led to demands that treatments be supplied by the
pharmaceutical industry at lower prices. This has brought governments in developing
regions into direct conflict with the pharmaceutical industry, which claims that the high
prices are necessary for it to be able to invest in R&D and bring newer medicines to
market.
With pharmaceutical companies taking a tough line over prices and in an effort to make
AIDS treatments available to sufferers at affordable prices, some developing countries
attempted to introduce cheap generic copies of anti-retroviral drugs. In addition, some
companies, such as Bombay-based Cipla, offered to supply patented drugs to charities
abroad at low prices.
These actions infuriated the pharmaceutical industry, which claimed that these moves
would break international patent law, damage its intellectual property rights and put its
future research efforts at risk.
South Africa defies the industry
In 1997, South Africa decided to bypass international guidelines on intellectual
property, stating that the enormity of the AIDS crisis gave it ‘medical emergency
status’. Under TRIPS Article 31, countries may use what is known as ‘compulsory
licensing’ for domestic pharmaceutical supplies during health emergencies, provided the
medicine is intended mainly for use in the domestic market. However, the exact
situations in which this clause could be invoked were vague and subject to
interpretation.
The pharmaceutical industry reacted by taking the South African government to court in
an attempt to block its efforts to use compulsory licensing, which would enable South
Africa to import or manufacture cheap generic versions of their drugs. In addition, the
pharmaceutical industry lobbied the US government for support against South Africa.
Although the US government did not become directly involved in the case against South
Africa, it did take part in initial negotiations.
The actions of the pharmaceutical industry were far from popular and many people
accused the pharmaceutical companies of putting profits before lives. The adverse
publicity that was generated caused all 39 companies involved in the litigation to
suddenly drop their case unconditionally in April 2001.

Table 8.1 Summary of pharmaceutical companies’ best ARV price
offers for developing countries (prices in US dollars per
adult per year)
NRTI
(abbreviation)
abacivir
(ABC)
didanosine
(ddI)
lamivudine
(3TC)
stavudine
(d4T)
zalcitabine
(ddC)
zidovudine
(ZDV/AZT)
Strength
(mg)
300 100 150 40 0.75 300
Europe/US
trade name
Ziagen
®
(GSK)
Videx
®
(BMS)
Epivir
®
(GSK)
Zerit
®
(BMS)
Hivid
®
(Roche)
Retrovir
®
(GSK)
Daily dose 2 4 2 2 3 2
BMS (US) 310 55
GSK (UK) 1,387 234 584
Roche(US) 161
Aurobindo
(India)
197 66 31 140
Cipla (India) 426 126 53 198
GPO
(Thailand)
650 163 73 277
Hetero
(India)
1,372 248 93 47 183
Ranbaxy
(India)
100 49 180
Prices are Free on Board (FOB) for generics’ manufacturers, and at least cost, insurance and
freight (CIF) for originator companies. All prices in other currencies than dollars were converted at
the rate in force when the offer was made. Prices are rounded up to whole numbers for easier
comparison. Annual costs are calculated according to the daily doses given in the WHO document
Scaling-up Antiretroviral Therapy in Resource Limited Settings: guidelines for a public health
approach, 22 April 2002.
Source: Médecins Sans Frontières
Although this appeared to open the way to the introduction of cheap anti-retroviral
drugs for South African patients, this has yet to happen. To a large extent this is due to
certain members of the South African government appearing to deny links between
AIDS and HIV, a view which has been severely criticised internationally.
Controversial use of generics in Brazil
Brazil has implemented one of the most successful anti-AIDS strategies in the
developing world by making affordable treatments available to sufferers, despite
opposition from the global pharmaceutical industry.
In 1998, Brazil began to produce its own generic versions of anti-retroviral drugs, and
this resulted in a 79% price decrease. Brazil has exploited a time lag until international
patent rules apply in the country. This has meant that a generic version of an anti-
retroviral combination cocktail that sells for $10,000–15,000 a year in the US can cost
$3,000 in Brazil. This situation came about from enacting a law that ‘guaranteed every
AIDS patient [in Brazil] state-of-the-art treatment’. It is widely quoted that this

programme has cut the national AIDS death rate by 50%. In addition, hospital
admissions for AIDS have fallen by 80% since 1996.
In 2001, a dispute arose between the US and Brazil over Article 68 of Brazil’s 1996
industrial property law, which imposed ‘local working’ (i.e. local production) of a
patented invention as a condition for enjoying exclusive patent rights. After heavy
lobbying by the pharmaceutical industry, the US government claimed that Article 68
discriminated against foreign owners of Brazilian patents and was in contravention of
WTO TRIPS guidelines.
However, the Brazilian government maintained that Article 68 was an integral
component of Brazil’s comprehensive anti-HIV/AIDS strategy. The Brazilian law
would require patented pharmaceuticals used in the treatment AIDS to be manufactured
locally. They argued that undoing this law would jeopardise Brazil’s efforts to fight the
AIDS crisis.
In June 2001 the US withdrew its opposition to the Brazilian law in return for further
discussion under a newly created bilateral consultative mechanism. In return, the
Brazilian government agreed to provide advance notice to the US government before
utilising the ‘local working’ clause in Article 68 of its industrial property law.
However, for AIDS activists the case had similarities to the South African situation and
they saw it as a victory against the international pharmaceutical industry. Once again,
they criticised the pharmaceutical industry for not being more understanding towards
AIDS sufferers in a developing country. Furthermore, in April 2001, the UN Human
Rights Commission voted overwhelmingly to support a Brazilian resolution calling for
universal medical treatment for people with HIV and AIDS.
In August 2001 there was more controversy when Brazil’s Health Minister threatened to
strip Roche pharmaceutical’s patent on the anti-AIDS drug nelfinavir after 6 months of
negotiations failed to lower the price. By manufacturing the drug locally, the minister
estimated that the price could be reduced by 40%. Although Brazil has manufactured
generic versions of anti-retrovirals, it is the first time it has openly threatened to strip a
patent.
Brazil is one of the few developing countries that has the technology to develop anti-
retroviral drugs and, as a result, has been helping other nations. Angola, for example,
has been receiving aid from Brazil to construct a pharmaceutical factory. Brazil is also
providing assistance to other Portuguese-speaking nations.
Where next for compulsory licensing?
In October 2001 a deal was struck at the WTO ministerial meeting in Doha, Qatar,
allowing countries facing a medical emergency to set aside the usually rigid WTO rules
concerning patents. For the first time, AIDS was considered a medical emergency. This
was seen as a victory for patient groups and non-governmental organisations.
It also puts Thailand in a strong position to be the next country to test WTO rules and
follow a similar route to Brazil. Before the Doha conference, Thailand had been

attempting to shorten the waiting period for a generic drug and this led it into a
confrontation with the US government.
Ironically, the issue of compulsory licensing has recently been thrown wide open by the
anthrax attacks in the US and appears to have led to a shift in the stance of Western
governments. Following the bioterrorist attacks, the Canadian government decided to
set aside Bayer’s patent on the antibiotic Cipro and order the antibiotic from the
Canadian company Apotex. The Canadian government did subsequently place the order
with Bayer, possibly to avoid a scandal, as Apotex had contributed money to the Liberal
Party.
However, what was more surprising was the manner in which the US government
obtained a discount from Bayer for the purchase of 100 million tablets of Cipro. The US
government decided to pay a price of US$0.95 per tablet to Bayer, which was below the
pre-September 11 price of US$1.77 and far below the wholesale price of US$4.67. The
pharmaceutical industry became concerned that the US government could claim a
medical emergency when there were actually only a few anthrax sufferers. It also feared
that it could lead to government pressure to reduce prices for drugs in disease areas such
as cancer, where the patient numbers were much higher.
The US government’s stance was considered particularly strange, as it had been
consistently opposed to moves by developing nations to introduce compulsory licensing
in order to control the AIDS epidemic. Furthermore, at the Doha conference, the US
government had opposed moves by developing countries to side-step patent laws in the
interest of public health, yet allegedly had been pressuring Bayer to reduce the price of
Cipro at around the same time.
The outlook for AIDS drug prices
The current situation has resulted in governments being at loggerheads with the
international pharmaceutical industry. Prices of AIDS treatments have fallen
significantly in the last 2 years, through deals with major companies, and this has
improved patient access in the developing world. Nevertheless, the pharmaceutical
industry argues that simply focusing on the price of drugs is not the answer to
effectively tackling AIDS and that governments should be doing more in terms of health
education and training for doctors. However, as the number of AIDS sufferers continues
to increase in developing countries, their governments continue to accuse the
pharmaceutical companies of putting profit before lives.
To some extent the pricing issue has been a diversion from what is really necessary to
tackle the AIDS crisis – an effective global strategy, featuring cooperation between
governments, pharmaceutical companies and non-governmental organisations. Playing
the blame game will serve only to delay efforts to tackle the crisis. Even if prices for
AIDS treatments are made lower, it must be remembered that these drugs do not cure
the disease and are no substitute for health education and effective preventive strategies.
Therefore, whilst pharmaceutical companies have an important role to play in fighting
AIDS and must do more, governments in the developing world must also face up to
their responsibilities.

In July 2002 the first signs of hope appeared at the 14th International AIDS Conference
in Barcelona. The conference, organised by the United Nations agency UNAids, was
attended by 15,000 delegates from over 190 countries. Delegates discussed programmes
to massively increase prevention strategies for AIDS, improve patient access to
treatments, set up a US$10bn global fund for fighting the epidemic and improve
measures for cooperation. To many observers, this was the first time that such a group
had agreed that there was no alternative to a global approach to halting the AIDS
epidemic. Although there is much more work to do, perhaps at last the fight against
AIDS appears to be heading in the right direction.
References
AIDS Education Global Information System. Available at http://www.aegis.com
Banta, D. (2001) Public health triumphs at WTO conference. Journal of the American
Medical Association 286(21), 2655–2656.
Kermani, F. (2000) Global Pharmaceutical Pricing: strategic issues and practical
guidelines. London: Urch Publishing (http://www.urchpublishing.com/).
Médicins Sans Frontières (June 2002) Untangling the web of price reductions.
Available at http:www.accessmed-msf.org
UNAIDS – Joint United Nations Programme on HIV/AIDS. Available at
http://www.unaids.org/
US Department of State International Information Program: Economic Issues. Available
at http://www.usinfo.state.gov/topical/econ/
About the author
Dr Faiz Kermani is based in the UK at Chiltern International, a contract research
organisation, where his responsibilities include budgets, proposals and marketing. He
previously worked in business development for CMR International, an organisation that
works closely with pharmaceutical companies on R&D strategies and regulatory issues.
He has also worked as a research analyst for Informedica A/S, a Danish healthcare
company, where he conducted research into European pharmaceutical industry trends,
pricing strategies and parallel importation. He holds a First Class Honours BSc in
Pharmacology with Toxicology from King’s College London and a PhD in
Immunopharmacology from St Thomas’s Hospital, London. He has published in various
areas of medical research, both in academia and the pharmaceutical industry.

CHAPTER 9
Trends in international pharmaceutical pricing and
reimbursement
Jorge Mestre-Ferrandiz, Industrial Economist, Office of Health Economics
(UK)
Article summary
The use of reference pricing in Europe has been growing in popularity since it
was first introduced in Germany in 1989. This article looks at the advantages
and disadvantages of both reference prices and international price comparisons
and their impact on final price and industry competitiveness. The author argues
that comparisons are very sensitive to exchange differential rates, choice of
weights and samples used, all of which can bias any inter-country comparisons.
Keywords
Competition, DDD, Exchange Rates, International Price Comparison, Reference
Pricing, Weighting
IN MOST EUROPEAN countries the market price is set separately from the
reimbursement4
price, the exception being Italy with medicines registered using the EU
centralised or the Mutual Recognition Procedure. Where reimbursement and pricing
decisions are separated, the whole process is usually a two-step procedure, as illustrated
in Figure 9.1.
The reimbursement decision is usually taken in stage 1. The payer, given the available
information, decides whether or not to reimburse the medicines. The following factors
are usually considered at this stage:
• therapeutic and social value of drug
• conditions treated
• cost of alternative treatments
• patient’s characteristics (age, income)
• own price.
4
Defined simply, the reimbursed price is the proportion of the total market price a third-party
payer (e.g. insurer or government) will pay for a medicine, the rest being paid by patients.

Figure 9.1 Reimbursement and pricing decisions
Stage 1
Stage 2
REIMBURSEMENT DECISION
PRICING DECISION
YES NO
Pharmaceutical
firms
FREE
Germany
Denmark
(US)
CONTROLS
Regulators and
Pharmaceutical
firms
FREE
Pharmaceutical
firms
REFERENCE
PRICES
Most EU countries in different
f orms f or branded and
generics:
•Direct/indirect price controls
(indiv idual or aggregate)
•Rate of return regulation
•Rev enue regulation
•OTCs f or most countries
•Hospital-exclusiv e
medicines in some
countries (direct
negotiations between
hospital and
manuf acturer)
Payer
Source: Office of Health Economics
After making this decision, the price is determined. There are several options,
depending on the outcome of the reimbursement decision (yes or no), the type of
medicine (prescription or over the counter – OTC) and the target market (community or
hospital).
If the payer says no to reimbursement, pharmaceutical firms are free to set the price.
This is the case for most OTCs in most countries, and hospital-exclusive medicines,
where there is usually a direct negotiation between the hospital and the manufacturer.
If the payer says yes, there are usually two options:
1. Companies have freedom to set the price (e.g. in Germany, Denmark and the US),
although firms are still subject to other constraints, especially in Germany and
Denmark, as discussed below.
2. Companies enter into another set of price negotiations, using new criteria in most
European countries. Price controls vary, but include direct or indirect price controls
(Spain), rate-of-return regulation (UK) and revenue controls (France).
The most common factors used to determine the price levels of medicines in these
negotiations are:
• therapeutic benefit

INTERNATIONAL PHARMACEUTICAL PRICING AND REIMBURSEMENT
• cost of medicine
• importance (value and volume) of medicine in the target market – actual (if
relevant) and forecast
• R&D expenditure
• promotional and marketing expenses
• prices of other treatments
• target population
• international prices.
It is difficult to single out the most important factors, as different countries have
different objectives, but the most likely are therapeutic benefit and cost. Interestingly,
for new medicines, international price comparisons are becoming increasingly
important. This issue will be discussed more thoroughly below.
Additionally, many countries are relying more heavily on reference prices. First
introduced in Germany in 1989, they are now used in some form or another in the
Czech Republic, Denmark, Hungary, Italy, The Netherlands, Norway, Spain and
Sweden.
Reference prices
Reference pricing is becoming very popular with payers. Initially it was used only in
countries where prices could be set freely, but now it is being applied in countries where
a contractual model exists. This reimbursement system categorises medicines into
groups with identical and/or similar active ingredient(s). There are three ways to
classify drugs: chemically, pharmacologically and by therapeutic equivalence, referred
to as group 1, 2 and 3, respectively. Chemical equivalence is where drugs in the group
have the same active ingredient. Pharmacological equivalence is where medicines
grouped together have comparable active ingredients, while therapeutic equivalence
occurs when medicines are not chemically comparable but have a similar therapeutic
effect. Once medicines are categorised and grouped, the authorities will define a
maximum reimbursement (reference) price, usually between the cheapest and most
expensive product of the group.
Firms are free to set their prices. Simply, when the price of a medicine is set above the
reference price, the patient pays the difference. If the price is below the reference price,
the patient usually does not pay anything. A more complex form of reference pricing is
where a government introduces additional patient co-payments.
Reference pricing has two main objectives: to increase price competition and to reduce
public pharmaceutical spending.
A problem with the market for medicines is the different objectives and incentives faced
by all participating parties: the prescriber, the patient and the payer. The patient

consumes the medicines but rarely decides or pays, the prescriber neither pays nor
consumes and the payer neither consumes nor decides. Hence, those who defend
reference pricing argue that this system gives economic incentives to patients to
influence the prescriber in his/her therapeutic decision, and so achieve an efficient
outcome. Producers might then reduce prices towards the reference price to maintain
market share, and public expenditure is reduced by having lower unit costs.
However, defining a product group, i.e. deciding which products to group together and
how to group them, is not easy. The key issue is how broad such group definitions are:
with a narrow definition, only multi-source drugs with the same active ingredient are
included; with a broader definition, different medicines still under patent with different
active ingredients are grouped together. International experience shows that the first
option is usually the preferred one for payers, and in some countries a necessary
condition to define a group is that at least one generic medicine exists. This has
implications for pharmaceutical pricing and market efficiency.
One necessary condition for the efficient implementation of reference prices is a well-
developed generics market. This is because the reference price is usually set around the
lowest market price, normally a generic drug if it exists. This is not, however, sufficient
to ensure that a reference price system achieves its (implicit) objectives; namely, to alter
prices rather than change patient demand. Two other conditions – high average prices
and significant price differences between products in the same group – are also needed
to maximise potential savings. The former is required because if prices are relatively
high the potential savings are greater; the latter is required to maximise potential
savings because if prices of products in the same group are very different this will
encourage price competition.
The incentives that firms face when setting prices subject to reference prices is also
analysed. Figure 9.2 illustrates the possible outcomes depending on how authorities
define what payment the patient should make towards the medicine. Two possible
scenarios are analysed.
Consider Case 1. This is the case when only reference prices are in place (e.g.
Germany). For simplicity, there are two pharmaceutical products with different prices,
P1 and P2, where P1 is higher than P2. As is common with this system, the reference
price (defined as RP in Figure 9.2) is set between P1 and P2. If the consumer buys the
expensive medicine (P1), he/she pays the difference; if the consumer buys the cheaper
product with a price lower than RP, he/she pays zero.
What will happen to prices set by firms? If the products are close substitutes, one
plausible result is that P1 decreases to RP, but P2 increases to RP. This is because the
high-price firm will lose too much market share and the cheaper producer knows that
the payer will finance up to RP. Hence, there is a cluster of prices around RP, so that
price competition is not really encouraged.
This result also raises issues regarding the setting of reference prices. If set too high, the
payer might end up paying more than before; but if too low, it might reduce profits,
thereby damaging R&D incentives.

Figure 9.2 The effects of reference pricing systems
RP
P1
P2
Patient’s net
payment
P1
– RP
0
P1
→ RP
P2
→ RP
Competition
reduced
Case 1: Reference Prices only
RP
P1
P2
Patient’s net
payment
(P1
– RP) + % RP
% P2
P1
→ RP
P2
→ RP
Case 2: Reference Prices and Co-payments
NOT
CLEAR
THAT
Source: Office of Health Economics
In Case 2 both reference prices and co-payments exist (e.g. Spain). Co-payments
usually take the form of a fixed payment or a percentage of the price. In this case, the
latter is assumed to exist. The analysis is similar to Case 1, but this time if the patient
buys the expensive medicine, he/she pays the difference plus the co-payment associated
with the RP. If the patient buys the cheaper product, he/she pays the co-payment
associated with P2.
The result under this scenario is not clear; however, it can be shown that the prices of
both medicines can actually decrease, so price competition is encouraged, but profits for
both firms are reduced (Mestre-Ferrandiz, 2002), which may discourage R&D in the
long term.
This simple example shows that co-payments are probably required if reference prices
are to achieve price competition.
What has happened to prices in countries that have implemented reference prices?
Pavcnik (2000), for example, has shown that in Germany the prices of branded
medicines above the reference price are reduced. Moreover, when generic competition
faced by branded-good producers is tougher, the reduction in price is higher.

However, in the medium and long term, reference prices have not always achieved the
second objective of reducing public pharmaceutical expenditure. There are various
reasons that help explain this result: reference prices cover only a limited proportion of
the market5
and can have perverse incentives that cause the prices to increase of those
products not subject to reference prices. Moreover, we have to take into account the
incentives faced by prescribers and pharmacists, which sometimes are not consistent
with prescribing and selling the cheaper products.
In summary, this section shows that, under reference pricing systems, not only is the
actual value of the reference price important for a firm’s pricing decision, but also the
amount patients pay.
International price comparisons
Another very important issue for setting domestic prices is the use of international price
comparisons, sometimes known as international reference pricing. The concept is
increasingly being used in pharmaceutical pricing negotiations. However, there are
many issues surrounding these comparisons.
The first is how to define a medicine. There are two possible options: defining a medicine
either by its active ingredient or, alternatively, by manufacturer. The second is how to
define the actual product price to use: define the price by cost of an active ingredient or,
alternatively, define the price according to its branded name or manufacturer.
Once the medicine is defined, the next step is to define the unit of consumption. There
are several options, including price per standard unit, per gram or per daily defined dose
(DDD). This is a crucial issue, as argued by Danzon and Chao (2000). These authors
argue that price per standard unit usually requires imputation when a particular product
pack does not exist in some country. This can lead to biased results because price per
pill varies significantly with strength and pack size in some countries. For example,
assume that there is one medicine available in two countries, with different packs. In
country A there is a 4 mg 28 pack,6
which costs £5, while in country B the same
medicine has a different pack size, a 2 mg 56 pack, and also costs £5. The DDD for this
medicine is 4 mg, so in principle the pack lasts for the same number of days in both
countries. Table 9.1 illustrates the price obtained if the price per DDD, per gram or per
standard unit (one pill) is used. The table also shows that the price per DDD and per
gram is the same for both countries. If the price per standard unit is compared, the price
in country B will be lower, hence the unit of measurement is important.
Table 9.1 Which method to use: price per DDD, per gram or per unit?
Cost (£) Price/DDD (£) Price/gram (£) Price/pill (£)
Country A – 4 mg 28 5 0.18 0.04 0.18
Country B – 2 mg 56 5 0.18 0.04 0.9
Source: Author’s own example/calculations
5
Recall that it has already been argued that reference prices are usually applied only to multi-
source medicines.
6
That is, there are 28 pills in the pack, each with a strength of 4 mg.

The impact of exchange rates
The second important issue is the exchange rate used. Market rates are subject to short-
and long-run instability, while annual average exchange rates can help reduce the
impact of instability. The study published by the English Department of Health
illustrates this fact. Table 9.2 shows their results (PPRS, 2001).
This study uses ex-manufacturer prices of all preparations for the top 150 branded
medicines in the UK, using UK weights. The first two rows (DoH 1, DoH 2) are based
on bilateral comparisons, while the second two rows (DoH 3, DoH 4) are multilateral
comparisons. A distinction between these two comparison methods has to be made.
Bilateral comparisons those made between one country and another and are for
medicines that are available in these two countries only. Multilateral comparisons,
however, are for global molecules that are available in all countries included in the
study. Hence, only those prices based on the same methodology can be compared.
Referring to Table 9.2, row 1 can be compared with row 2, but not with rows 3 or 4.
Similarly, prices between rows 3 and 4 can be compared.
Row 1 shows prices for a bilateral comparison study at the 2000 market exchange rate,
while row 2 uses a 5-year average exchange rate, where the exchange rate uses 2000
price information but is converted to sterling using the average exchange rate for the
period 1996–2000. The same principle applies for rows 3 and 4, but here the study is
based on a multilateral comparison study.
Table 9.2 shows that different results are obtained, depending on the exchange rate
used. As an illustrative example, the price in Germany can be higher or lower than the
UK’s, depending on the exchange rate used.
Additionally, product life-cycle characteristics need to be considered, since comparisons
are usually based on a single point in time. This is particularly relevant because
countries use different regulatory policies, which influence firms’ pricing strategies (i.e.
set an initial high price and then decrease it, or have a more stable price throughout the
life cycle). Also, since not all medicines enter all countries at the same time, prices for
the same medicine can be different between countries because they are at different
stages in their life cycle.
Furthermore, most current data and analysis do not take into account the discounts
offered to payers because they are not available publicly. This is especially true for the
US, where discounts are very common. Consequently, most studies show higher prices
than the payer actually pays, sometimes resulting in an upward bias for the US.
Table 9.2 Effects of using different exchange rates
Row US UK Germany France Italy
1 DoH 1 209 100 80 79
2 DoH 2 189 100 103 96 90
3 DoH 3 243 100 94 83 82
4 DoH 4 220 100 108 94 93
91
Source: PPRS (2001)

Choice of weights and sample
Nevertheless, the most important factors are the choice of weights and the sample used.
Prices are usually weighted with quantities in order to balance the relative importance of
medicine consumption patterns. For example, a very expensive medicine might exist,
but with minimal consumption compared with, say, a medicine that is very cheap but
very widely used. If prices are not weighted by their relative consumption, then in
principle the standard average price will be very high, since the relative importance of
both medicines is the same. However, the resulting average price will be lower when
prices are weighted with their corresponding quantities because the relative importance
of the cheapest product is higher.
Weights are needed because they show that the pattern of medicine use varies greatly
from country to country. The choice of weights is thus very important. For example,
when a study uses UK weights, it means that the results will show how UK total
expenditure will change if it were to adopt another country’s price but make no change
in its relative consumption pattern. Alternatively, if non-UK weights are used, results
will show how UK drug expenditures will change if, say, the UK were to adopt French
price levels and French utilisation patterns.
In order to illustrate the importance of the choice of weights, consider the following
example, which is taken from Danzon and Chao (2000). This study uses IMS data from
retail pharmacies between October 1991 and September 1992. The drug is defined by
active ingredient and three-digit ATC, regardless of manufacturer or brand name. The
price of each molecule is a weighted average price, based on all products in the
molecule, including originator, licensed, generic and those OTCs that meet sample
criteria. The results are shown in Table 9.3.
The first four rows (D&C 1–D&C 4) use the US as the base country, with the first two
being a bilateral comparison and the third and fourth a multilateral one. Hence, rows 1 and
2 can be compared with each other, as well as rows 3 and 4. Row 1 uses US weights, while
row 2 uses non-US weights. Comparing results between these two rows leads to very
different results. For example, prices in Germany can be higher than in the US. Moreover,
figures in row 2 are consistently lower than row 1. A similar pattern is found when rows 3
and 4 are compared. Row 3 uses US weights, while row 4 uses non-US weights.
Table 9.3 Effect of using different weights in pharmaceutical price
comparisons
Row US UK Germany France Italy
1 D&C 1 100 83 125 8 7
2 D&C 2 100 56 0 3 9
3 D&C 3 100 88 119 0 1
4 D&C 4 100 63 6 6 4
5 D&C 5 179 100 229 104 179
6 D&C 6 120 100 104 1 5
7 D&C 7 159 100 146 9 131
8 D&C 8 113 100 101 2 105
6 8
4 3 4
7 9
3 3 5
7 6
9
8
Source: Danzon and Chao (2000)

Alternatively, the UK is the base country in rows 5–8, with rows 5 and 6 based on a
bilateral comparison study and rows 7 and 8 based on a multilateral study. Again, the
odd rows use UK weights while the even rows use non-UK weights.
Results vary depending on the choice of weights. For example, the price in France can
be higher than the UK with a bilateral study using UK weights (104 versus 100).
However, for the other three possible scenarios, the price in France is lower than in the
UK. Moreover, prices in the UK can be roughly similar to Germany and Italy, or much
lower.
In principle, the relevant index for each country should be its own utilisation, as
quantity weights reflect the relative importance of different products in total
expenditure.
The second major issue is the sample used, and this is where bilateral and multilateral
comparison studies come into play. There is a trade-off between comparativeness and
size of sample.
Bilateral studies allow comparisons between the base country and each country, but not
between the non-base countries. Multilateral studies, however, allow for comparisons
between all countries because they include medicines available in all countries – global
molecules. Hence, there is a trade-off; in multilateral comparisons, examples of
medicines available in the same form in all countries are rare and so sample sizes are
small. In bilateral studies, the sample is larger but one cannot compare between all
countries.
In addition there is a concern over whether to include branded and non-branded
products. Some older studies used only leading branded products, and results do vary if
generics are introduced. This is particularly important because the development of
generics is very different between countries. This has some implications, because the
introduction of generic medicines usually increases price competition. Moreover,
countries that use cheaper drugs will usually show lower prices if the weights used are
their own country’s quantities.
Which is the best methodology to use? It depends on what is to be compared and what
the results are wanted for. If the objective is to compare prices for a specific set of
medicines, then the best option is to concentrate on those medicines, including branded
and generic versions if available. If, on the other hand, comparisons are based on
broader terms, the best methodology will depend on the available data. If the database
has many global molecules, then a multilateral study will be appropriate; however, if
this is not the case, a bilateral study will have to be used, but taking into account that
comparisons between all countries in the sample will be limited.
Conclusion
There are a wide variety of approaches to use in the pricing and reimbursement
decision. There is no universal method for dealing with such issues. Different countries
face different constraints and objectives, and accordingly use different approaches.
Moreover, national cultures and habits in prescribing and utilisation of medicines are
also very important, so there is no one-size-fits-all method.

Reference prices are growing in importance in setting domestic prices and controlling
expenditure on drugs, although results have not always fulfilled expectations. Both
payers and firms have to take into account that some factors play a very important role
when setting the price of the products subject to reference prices, including both price
sensitivity and the existence of co-payments.
Finally, international price comparisons are used increasingly by purchasers as part of
the pricing decision or in the price-setting negotiations, and some of the associated
problems have been highlighted. When ‘international reference pricing’ is used, the
price of the product when launched is determined, at least partly, by the price in other
countries. It is important to use an appropriate international ‘average’ price, since the
higher the international price, the higher the price the firm will be able to set. As clearly
shown, this figure is very sensitive to the methodology used, especially to the choice of
basket and weights used. Choice of methodology will ultimately impact on national
drug bills for governments, price competition and the long-term return on R&D for
pharmaceutical companies.
References
Danzon, P. and Chao, L. (2000) Prices, Competition and Regulation in
Pharmaceuticals: a cross-national comparison. London: Office of Health Economics.
Mestre-Ferrandiz, J. (2002) Reference prices: the Spanish way. Investigaciones
Economicas.
Pavcnik, N. (2000) Do Pharmaceutical Firms Respond to Insurance? NBER Working
Paper No. 7685.
PPRS (December 2001) Fifth Report to Parliament. Available at
www.doh.gov.uk/pprs/5report.htm
About the author
Jorge Mestre-Ferrandiz joined the Office of Health Economics (OHE) in October 2001 as
an industrial economics researcher. His current research focus is the analysis of
European pricing and reimbursement systems. He has contributed to the
ABPI/Department of Health Pharmaceutical Price Regulation Scheme competition
studies. Prior to joining the OHE, Jorge conducted research for the Economics Advisory
Group to provide in-depth understanding of how to introduce new hospital drugs for
multiple sclerosis and Crohn’s disease into the Spanish market. He completed his
doctoral thesis ‘Essays on the pharmaceutical industry’ at Universidad Autonoma de
Barcelona, Spain, in January 2002.

CHAPTER 10
The future of parallel trade in pharmaceuticals in Europe
Klaus Hilleke, Senior Partner, Simon Kucher & Partners (Germany)
Article summary
Parallel-imported pharmaceuticals make up the fastest-growing sector of the
pharmaceutical market. European courts have repeatedly ruled in favour of
parallel traders, who are generally free to export drugs from one country to
another, to repackage products and to make direct or indirect use of
trademarks. This article reviews the pharmaceutical industry’s defences against
parallel importing and the future of the business.
Keywords
Dosage Forms, Exchange Rates, Pack Sizes, Parallel Trade, Supply Chain
Management, Strategies
TWO KEY PRINCIPLES support the parallel trade of pharmaceuticals in Europe.
The first, one of the fundamental tenets of the EU, is the free movement of goods, as
outlined in Articles 30 and 36 of the Treaty of Rome. The second, upheld repeatedly
by the European Court of Justice (ECJ), is the exhaustion of patent or trademark
rights, which dictates that a patent holder who markets a product in any EU member
state cannot then control that product’s distribution or marketing in another EU state.
In other words, bringing a product to market exhausts its patent and trademark rights.
These two principles form the legal basis for parallel trade, which refers to the
practice of buying up drugs in countries with low prices, exporting the products to
countries with higher prices (often the original exporting country), and then
undercutting the trademark holder’s chosen price for these drugs in the destination
market.
The commercial basis for parallel trade is the existence of different prices for the
same product in different member states. Price differences exist for three main
reasons:
• Manufacturers’ decentralised sales and marketing strategies lead to prices defined
on a country-by-country basis without considering pan-European implications.
• Currency exchange-rate fluctuations have led to price divergences. Because many
countries only permit drug prices to move downwards, it is impossible for
manufacturers to raise prices to compensate for exchange-rate variations.
Additionally, many countries have forced companies to lower prices for drugs.

• Variations in pricing and reimbursement regulations among EU member states
make it virtually impossible for companies to establish or maintain homogeneous
prices unless they accept the lowest price in all markets.
Pharmaceutical companies are caught in a dilemma: they must comply with the
European law requiring the free movement of goods, but they often have little control
over the prices of these goods.
Spain, France, Italy, Portugal and Greece are known as the main exporting countries;
The Netherlands, the UK, Denmark, Germany, Norway and Sweden are the key
importing countries. However, the exact movement of products varies from drug class
to drug class and depends on individual countries’ pricing structures. For example, the
UK is a major importer of therapies for disorders of the central nervous system,
whereas it is an important exporter of oral contraceptives.
Parallel importing began in the early 1970s, but its impact on the market was initially
negligible. Realising the lucrative potential of this business, the importers gradually
began expanding their reach, and parallel trade grew rapidly in the late 1980s and the
1990s. Table 10.1 shows the evolution of parallel imports in some of the most important
European markets. The general trend is clear: a steady increase in market share for
parallel imports in all these countries. In many European countries, parallel imports now
make up the fastest-growing sector of the pharmaceutical market, with overall sales
growth rates of 15–25% per year and even higher increases for particular products. In
some instances, parallel imports can account for as much as 70–80% of a drug’s total
sales in certain markets. The UK and The Netherlands are among the most important
markets for parallel imports, which account for 10% and 15%, respectively, of total
pharmaceutical sales in these countries. Germany is catching up fast, with a share of
more than 7% in the first quarter of 2002, up 96% compared with the same quarter in
2001. Overall, the share of parallel imports in Europe is about 5%.
Parallel imports are typically priced between 5% and 10% below the original products.
With pharmacists in Germany being forced to have a minimum share of parallel
imports, prices have risen and today there is often a price difference of less than 5%.
However, the price differentials vary from country to country, as well as from parallel
importer to parallel importer.
Table 10.1 Market share of parallel imports in key European markets
in selected years, by value
Country 1990 1991 1996 1997 1999 2001
Denmark 0 1 6 9 10 11
Germany 1 1 2 2 5 5
The Netherlands 5 8 18 8 15 9
UK 8 10 5 7 8 15
Sweden n.a. n.a. n.a. 2 9 10
Norway n.a. n.a. n.a. 4 7 5
n.a. = information not available.
Source: Company reports, NERA, Eurimpharm

THE FUTURE OF PARALLEL TRADE IN PHARMACEUTICALS IN EUROPE
With prices for branded drugs varying by as much as 60–80% across Europe, much
more than the savings offered by parallel imports, it is evident that parallel trade
benefits mainly parallel traders. For every $6 that pharmaceutical manufacturers lose in
revenue, patients and/or healthcare systems save only $1 on average; the other $5
represents the parallel traders’ operating margin. Additionally, the GDP of the
importing country is negatively affected and the loss of income from direct and indirect
taxes can be as high as $2 for every $1 saved in the drug budget.
The industry’s options for dealing with parallel imports
Parallel imports present a difficult dilemma for drug manufacturers to cope with. On the
one hand, they cannot prevent the free movement of identical goods. On the other hand,
the pricing and reimbursement regulations in most European countries allow only
minimum influence on price changes upwards. The only readily available response to
solve the price disparity problem in Europe would be to lower the prices to the lowest
level in Europe. However, such action could mean an almost immediate profit reduction
of more than 80%.
Pharmaceutical companies have tried a number of strategies to counter parallel importing;
however, as the following brief overview will show, none of them really work.
Different pack sizes
Distinguishing products by introducing different pack sizes in different markets offers
one possible defence. However, the ECJ has ruled in several cases that parallel
importers may repackage drugs. For example, a parallel importer might cut a 30-tablet
blister pack into three smaller blisters or might combine three 10-tablet blisters into a
30-tablet package. Prior authorisation by the trademark owner is not required. Although
the ECJ did set some rules for repackaging, these rules are not really a barrier.
Different dosage forms
Launching a product as tablets in one country and capsules elsewhere is technically
possible, but only if a company bypasses the European Medicines Evaluation Agency
(EMEA) and registers the drug in question in each country separately. In an initial
launch, the extra cost of developing two dosage forms and the opportunity cost of
possibly not having the optimal product or range of products available in all countries
may exceed any benefits of differentiation. However, introducing new dosage forms or
formulations at a later stage can be worthwhile.
A new weakness in the dosage-differentiation strategy arises from the ECJ’s recent
ruling that in cases where the trademark owner has withdrawn the initial registration of
a product in a particular country, and no longer sells the drug there, parallel traders may
continue to import the old product and pharmacists may continue to dispense it for
prescriptions that mention the brand name but do not specify the new formulation.
Different brand names
Drugs registered through EMEA’s centralised procedure must have the same brand
name in all member states, but different brand names can be used in the case of drugs
registered by other means. Some companies have adopted this approach as a defensive
measure against parallel importing. However, in the case of Pharmacia v. Paranova, the
ECJ granted the parallel trader the right to rename an otherwise identical product to

match the brand name in the import country. In a more recent decision in the UK the
High Court concluded that a parallel trader may rename an imported product if it is
identical to the one sold in the UK and the activity does not otherwise damage the
trademark holder’s rights.
Supply chain management
A recent decision from the European Court of First Instance regarding the Bayer-Adalat
case suggests that supply chain management can be used to limit, but not to stop,
parallel importing. When Bayer discovered that most of the parallel imports of Adalat
into the UK came from Spain and France, it sharply reduced its supply of the drug to the
source countries, thereby curbing the potential for parallel exporting. While the
European Commission had argued that Bayer had imposed an export ban on Adalat and
fined the company €3m, the Court of First Instance overturned that decision and
basically defined some rules as to when supply chain management might be acceptable.
The European Commission has lodged an appeal, and a final decision is expected in
2003.
Withholding or withdrawing products from certain markets
In a bid to differentiate markets, manufacturers sometimes decide not to launch
particular formulations in certain markets. However, withholding or withdrawing a drug
completely from a market may be inadvisable, particularly if the agent has life-saving
potential or if no alternative therapies are available. Ethical considerations may have to
take precedence over direct commercial interests. Furthermore, any drug registered
through EMEA’s centralised procedure will be available to patients in all member
states, even if the company chooses not to market it in a particular country. In addition,
boycotting a large market (such as France) to reduce the risk of parallel trade could
result in a substantial loss of potential revenue.
Pricing strategies
The most promising counterstrategy to parallel trade targets price differences, the very
heart of the practice. To succeed, pricing strategies must be applied before launching the
product. The most effective way for a manufacturer to limit the impact of parallel trade
is to minimise inter-country price differences. This objective can be achieved by one of
two methods: (1) uniform pricing or (2) a price corridor.
A single price throughout the EU may seem appealing but it is almost impossible to
achieve. Manufacturers currently have to negotiate prices with individual national
authorities and getting the same price everywhere could be a very lengthy process.
However, given the different purchasing powers across the EU, and the different
willingness and ability of healthcare systems to pay for certain therapies, uniform
pricing may not be desirable even if it were attainable. Indeed, it is an established
element of price theory that differentiated prices lead to superior profitability.
Companies that pursue a uniform pricing strategy forfeit potential profit.
Most pharmaceutical companies now use the price corridor as the standard strategy for
new product launches in Europe. However, we believe that this concept should also
serve as the guiding principle for global pricing strategies. Figure 10.1 illustrates the
concept of the global price corridor.

Figure 10.1 The global price corridor
Ma ximum pr ice
Ma ximum pr ic e
Ma ximum pr ic e
Min imum price
Min imum pric e
Min imum pric e
Europe America Asia
Global Maximum Price
Global Minimum Price
Source: Simon Kucher & Partners
This concept is based on the premise that prices worldwide must fit into the global price
band as well as into the price band defined for their own region.
The price corridor strategy requires raising prices to at least the minimum price in
countries where the optimal price is below the minimum price. Further, the product
must not be launched in countries where it is not possible to achieve at least the
minimum price. In countries where reimbursement at target prices cannot be achieved,
companies should launch the product without reimbursement, if possible.
Properly applied, the price corridor strategy is the only approach that has proved to be
effective in the long term, but even this defence has limitations. The gradual divergence of
prices for reasons beyond the control of pharmaceutical companies can reduce its impact.
The imposition of price cuts by health authorities as well as currency fluctuations in
Europe’s non-euro zone can make it difficult to maintain the original corridor width.
The future of parallel trade and its impact on European pharmaceutical markets
Several key influences will shape the future of parallel trade in Europe. Figure 10.2
summarises these factors and illustrates whether they positively (+) or negatively (–)
affect the future of parallel trade in Europe.
National price controls
Parallel imports exist largely because of national price controls, which are the most often
cited argument for exempting the pharmaceutical industry from the principle of the free
movement of goods in the EU. However, EU courts have repeatedly rejected that
argument. The Maastricht Treaty’s exclusion of social security systems from European
harmonisation will prevent any real convergence of pricing and reimbursement systems in
Europe in the near future. A harmonised European system seems elusive.

Figure 10.2 Factors influencing the future of parallel trade in Europe
Future
Parallel Trade
in Europe
Combined forces
of parallel trad ers
(EAEPC)
2
Parallel trade
erosio nof its own
comp etitive base
3
Political
intervention
4
Pan-European
p ricing strategies
5
Excha nge-
rate
flu ctuations
7
Euro
currency
8
Non-p ricing
counter-
me asu res by
manufacturers
6
+
+
-
+
-
-
-
-
Na tion al
price
controls
1
Source: Simon Kucher & Partners
Combined forces of parallel traders
As the umbrella organisation of European parallel traders, the European Association of
Euro-Pharmaceutical Companies (EAEPC) was established specifically
to promote and co-operate in the development of parallel trade as a means of
establishing a unified market within the EU, providing medicines to all
citizens at affordable prices. The EAEPC and its national member
organisations are actively encouraging co-operations, on EU and national
level, with all relevant and interested parties such as governments, authorities,
as well as professional and patient/consumer organisations.
EAEPC appears to have a receptive audience. The public has come to see parallel
imports as a means of saving national healthcare systems substantial sums and to regard
parallel traders as modern Robin Hoods who take from the rich (pharmaceutical
manufacturers) and give to the poor (patients and healthcare systems).
Parallel trade’s erosion of its own competitive base
The only competitive advantage of parallel imports is their price. Pharmaceutical
manufacturers have historically allowed price differences to exist because they did not
see parallel imports as a major problem, and some companies still largely ignore the
negative effects of parallel imports. However, most companies have adopted measures
to keep price spreads as narrow as possible by:
• creating price corridors at the time of new product launches

• reducing prices when the market share of parallel imports grows too large
• launching line extensions selectively
• reducing prices of less-affected products only when forced by price controls to do
so.
All these measures have reduced the price differences among countries, thereby
removing the primary reason for the existence of parallel imports. Parallel traders are
likely to respond by adding drugs to their portfolios that offer them only a modest
margin, but pharmaceutical companies will suffer a much smaller negative impact.
However, the difficulties caused by parallel trade in terms of motivation of the sales
force and internal fighting over profits and revenues will remain.
Political intervention
A political solution to the parallel trade problem could take either of two possible
forms: (1) restricting the free movement of goods or (2) abolishing domestic price
controls. Neither is likely to happen. Restricting the free movement of goods would
violate one of the most fundamental principles of the EU, and a total abolition of price
controls in the member states would require a drastic change in overall healthcare
policy. However, health authorities have been fairly receptive to manufacturers’ desire
for homogeneous pricing in Europe and have accepted a narrow price band for
innovative new drugs (although not for ‘me-too’ or ‘near me-too’ products).
Pan-European pricing strategies by manufacturers
As discussed above, manufacturers are increasingly adopting measures to keep price
differences among countries too small to offer a viable business opportunity for parallel
traders. With many of the most lucrative drugs for parallel traders facing patent
expiration and generic competition, the recent double-digit growth rates in the market
for parallel imports can scarcely continue indefinitely. However, the full impact of these
trends will not be felt until the second half of the current decade.
Non-pricing countermeasures by manufacturers
Product differentiation offers little defence against parallel importing because, as noted
above, European courts have ruled that parallel traders may engage in practices such as
repackaging, rebranding and (where formulation is not specified) importing dosage
forms that have been withdrawn from a particular market. Moreover, in the case of
drugs approved through EMEA’s centralised procedure, any attempt at differentiation of
the core product would most likely be considered an illegal violation of the single
market. Manufacturers should launch new formulations only if they can establish a
European price corridor.
As mentioned above, some companies have tried to imitate the supply chain
management strategy that Bayer used to restrict the supply of Adalat in Spain. Provided
the European Commission’s appeal remains open, this is a viable option, assuming that
they comply with the legal requirements defined by the Court of First Instance.
However, it now appears that the European Commission is looking into whether some
companies are abusing their dominant position in some of the indications affected by
supply chain management.

Exchange-rate fluctuations
In contrast to countries within the euro zone, the UK, Sweden and Denmark will
continue to be affected by exchange-rate fluctuations against each other’s currencies
and the euro. If the euro weakens significantly, price differentials will grow and
countries outside the euro zone will become more vulnerable to parallel importing. Of
course, the euro may also strengthen, a development that would reduce the price
differential and discourage parallel trade.
The introduction of the euro
The introduction of the euro has led mainly to an increased price transparency that will
force companies to reduce price differentials faster. The existence of a single currency
in most EU member states will encourage a more uniform pricing structure.
Additionally, having a single European currency will induce politicians and pricing
authorities to pressure the pharmaceutical industry into adopting more uniform pricing.
However, the introduction of a single European currency will not lead to a need for a
single European price.
About the author
Klaus Hilleke, PhD, is a senior partner at Simon Kucher & Partners, a globally operating
strategy and marketing consultancy. He is the global co-leader of the company’s life
science division. He has been with the company since 1988. From 1996 to 1999 he was
the founding partner and managing director of the company’s US office in Cambridge,
Massachusetts. Email: khilleke@simon-kucher.com

CHAPTER 11
Pricing considerations for new products in Europe
Roland Pfeiffer, Integration Manager Europe, Altana Pharma AG
Article summary
Achieving the best price for a product requires the manager to take a top-down
view of all factors influencing the drug’s profitability. This article summarises
those elements that a pharmaceutical company should consider when setting
prices for the European market.
Keywords
Celebrex, Cross-border Referencing, Launch Sequencing, Maximum Price,
Parallel Trade, Price Corridor
National price setting
WHEN APPROACHING THE TASK of setting the price7
for a new drug, a national or
class comparison with existing products is usually the first approach taken by the
authorities. If a new chemical entity (NCE) does not belong to an established class – in
effect founding a new anatomic therapeutic classification (ATC) class – authorities tend
to switch to a relation based on indications, with the same aim: having a comparison to
already-marketed products.
With that, the authorities will endeavour to find reasons for rating the new drug lower
than the existing ones, for example by using a comparative scale that refers directly to
known products (such as the ASMR – Amélioration du Service Médical Rendu – rating
in France). This should help them in justifying discounts as high as possible.
It is at this stage that the pharmaceutical companies must be well prepared to argue for
their product, showing the advantages of their drug over existing ones. This can be done
convincingly only if the appropriate clinical data are available – hence, trials need to be
designed accordingly. This is by no means assured, as the clinical development of a
drug usually takes a cautious approach (e.g. by using comparators and endpoints where
a positive outcome for the NCE is very probable), ending up with data sufficient for
obtaining registration but not for obtaining a good price. The antagonism between a
7
Many countries distinguish between an official maximum price for a drug – i.e. the highest price a
pharmaceutical company can ask for in that market – and the reimbursed price that social security or
any other corresponding authority is willing to cover. In this article, ‘price’ refers to the ‘relevant
price’ for the pharmaceutical industry, in the sense of the reimbursed price in most countries (where
patients are not used to paying considerable amounts for their medicine) or simply the maximum
price (in countries such as France, where additional private insurance covers most patients’ official
co-payment). Thus, ‘price’ means either the maximum or the reimbursed price, both to be negotiated
with authorities in all European countries except Germany and the UK.

cautious clinical development approach and the ‘daring’ needs of pricing and
reimbursement (P&R) managers stresses the importance of P&R units getting involved
early on in the clinical development process – not later than in phase II. It is crucial here
to have the input from local managers as well, so at least the major countries’ P&R
needs are considered at an early stage.
Another factor is health outcomes data, which are of growing importance and are being
required by an increasing number of national authorities. Yet it is not clear to what
degree these data are of tangible use, as they are judged with some suspicion.
The overall aims when introducing a drug are to have a high price, quick market access,
a high rate of reimbursement and no prescribing limitations (i.e. a large patient
population).
Yet a study by Cambridge Pharma Consultancy (European Pricing & Reimbursement
Review 2001) has shown an increased tendency of pharmaceutical companies to sacrifice
a good price for quick market access (e.g. in France). The problem here is that making
large concessions on price (such as in the well-known Celebrex deal in which future
substantial price cuts were agreed upon with the French authorities) does not ensure short
negotiation times – so one might end up with a lower price and late market access. One
should always bear in mind that price is the single most important parameter determining
profitability per unit, and it should be handled with appropriate care.
International referencing
In a second step, prices of new drugs in other countries are considered. There is a
tendency to combine national and cross-border comparisons in a single step and to take
the lower of the two results as the starting point for bargaining (e.g. in Switzerland).
Cross-border referencing is now used officially by 13 of 16 EU countries, and by most
of the future EU entrants in Eastern Europe. Like most cost-containment measures
targeting industry, this one is applied to an increasing degree, as shown, for example, by
Switzerland and its recent inclusion of the UK in its basket of countries.
The main problem with international referencing lies in the unpredictable approach
taken by the authorities in most countries – this means that there is no distinct set of
basket countries that are referenced, the result being that the authorities might relate to
changing groups of countries at their discretion, or not care about prices abroad at all.
Secondly, the method of calculation may not be well defined and can thus vary greatly,
turning price negotiations into a kind of roulette.
All this limits the usefulness of any mathematical models designed to simulate all
interdependencies. Basically, cross-border referencing is a network problem defined by
three parameters: connectivity (referencing), time (delays in market entry) and price
(national estimates as a starting point). As the first of these parameters is unclear in
many cases (informal/unpredictable referencing), and as this omits the influence of the
‘bargaining factor’, any automated models should be used with caution.
Another point is registration: the Mutual Recognition Procedure allows for much greater
leeway than the Centralised Procedure because of the variability in pack sizes, local

PRICING CONSIDERATIONS FOR NEW PRODUCTS IN EUROPE
indications, brand names, and so on. The recent squabble between the European
authorities and industry on this issue is an indication of industry’s strong preference for
maintaining the option to differentiate its products between countries.
Given the high degree of uncertainty in the approach of national authorities to pricing, it
is paramount to ensure good relations with them, and to meet their individual needs by
designing P&R dossiers locally – with a focus on what they actually are, not as an
abbreviated by-product of the registration dossier.
Cross-border referencing entails another potential source of discontent to industry: in
some countries (e.g. The Netherlands), prices are updated regularly by comparing them
with the respective basket countries. This limits the use of sensible launch sequencing
(see below) in these markets and highlights another issue that is forgotten all too often:
the need for life-cycle management in pricing (which is not the issue here) should be
kept in mind when setting up P&R structures.
International price comparisons should be remembered when it comes to price–volume
deals. Such deals have become an issue since the above-mentioned Celebrex case in
France, where later price reductions had been agreed upon at launch. With France being
one of the most referenced countries in Europe, the detrimental effects on other markets
from such a deal have the potential to be considerable. Hence, price–volume deals, in
the form of maintaining a high price level while agreeing on pay-back if a certain
volume is exceeded, might be an alternative well worth considering.
Taking into account the matter of cross-border referencing, one could start thinking
about the optimal sequence of launching one’s product in Europe but for another issue:
parallel trade.
Parallel trade
The parallel trade (PT) of drugs is a well-established business in the UK, where it
accounts for a considerable proportion of sales. Having formerly been quite limited,
changes in legislation have encouraged PT in Germany (see Figure 11.1). This
positive payer attitude, as well as the increased use of the Centralised Authorisation
Procedure (with its concomitant uniformity of pack sizes, brand names, indications,
etc.) and increased price transparency following the introduction of the euro, will help
PT to outperform the total Rx market: estimates for 2000 put parallel imports at 4–5%
of total European drug revenues (EFPIA), and we can expect this figure to double by
2006.
All attempts by manufacturing industry to block PT legally have more or less failed and
have even facilitated the business of parallel traders as the legal frame has become
increasingly defined through successive legal verdicts in favour of parallel traders.
Actively blocking drug exports from any EU country is forbidden outright, as is
collusion with traders.
The use of different brand names, varying pack sizes, disposable packs and so on have
all proved to be of little long-term effect whenever price differentials have been
sufficiently high to ensure a good margin to arbitrageurs.

Figure 11.1 Market share of parallel imports in Germany
1.80
2.20
3.20
4.70
7.50
0
1
2
3
4
5
6
7
8
1998 1999 2000 2001 Jul-02
%marketshare
Source: IMS Health, NDCHealth, EFPIA
The only pre-emptive measure to contain PT is to reduce price differences between
European countries, thus turning arbitrage into an unattractive business. Hence,
European (or even worldwide) price corridors or minimum prices are considered the
method of choice.
Price corridors
The major rationale for limiting price spreads in Europe is, as mentioned above, the
attempt to limit PT exposure. This should always be kept in mind – price convergence is
not an aim in itself.
The problem here lies in the fact that existing price differentials between EU countries
are considerable and, as described above, price setting by authorities involves national
comparisons, with the result that current price differences will slowly decline. Hence,
existing price levels in most countries are the starting point for the pricing of new drugs,
even if they belong to existing or to new ATC classes.
Another issue is that PT is not predictable, meaning that the potential losses due to
arbitrage are very uncertain. Contrarily, any losses incurred by voluntarily decreasing a
drug’s price in a single country in order to remain within pan-European limits, are
certain. As PT is an issue that has to be lived with, to a certain degree, setting a price
band must not mean being content with sub-optimal prices in order to minimise PT.
Any upper limit in such a price corridor is soft, whereas the lower limits are hard (i.e.
binding). Prices above the corridor are welcome, those below need special attention. A
spread is usually set at average/median ±10%, based on national price estimates.
The problem is where the limits should be set. Quite probably, a first round of national
price estimates will yield differentials of up to 100% (as seen from the lowest). One will
try to set the band as high as possible, by analysing for each of the lower outliers
whether there are any means of increasing their price (see below) or whether not
launching there at all is outweighed by the probable gain in other markets. Special focus

PRICING CONSIDERATIONS FOR NEW PRODUCTS IN EUROPE
should be put on the top five countries covering 80% of the total European market.
Again, losses are certain, whereas gains are not.
Also, internal issues may play a significant role: production costs or affordable
marketing and sales costs as well as the overall strategy for this drug (is it a ‘door-
opener’ for entering a new market, or is it supposed to become a cash cow?) and regard
to the importance of individual markets (is any country of particular importance to
others, e.g. because it is viewed as the opinion leaders’ place in that indication?). These
should be clarified early on at senior level and taken into account accordingly. As
regards PT, a choice might be made to run risks in launching in low-priced markets if it
is believed that the flow of goods can be controlled reasonably well.
Therefore, the difficult part comes when addressing the outliers. If the national estimate
for any one country lies below the corridor then ways of raising the price should be
sought, e.g. by limiting the indications, by delaying launch to optimise the sequence
from a pricing point of view, by launching without reimbursement or by not launching
in that country at all. These risk factors for the product’s success in a single market may
thereby be turned into opportunities at a pan-European level – sacrifices in some
markets might have to be made for advantages in others.
Launch sequencing
Determining the optimal sequence for launching a new drug in Europe is a synthesis of
cross-border referencing, based on national price estimates, and the implications of
parallel trade. Yet the leeway is limited, as the time frame is set to a large degree by the
delays incurred by national authorities in agreeing on a price (maximum and/or
reimbursed price; see Figure 11.2). This is particularly the case if the Mutual
Recognition Procedure is chosen for registration, as an additional delay ensues from the
need to have national approval in each country, thereby adding to the delay caused by
the P&R process.
Moreover, an additional, artificial delay in launching a product in one country is rarely
offset by a gain in another. Exceptions may be small markets having a direct effect on
the price in large markets. Therefore, it is advisable to start P&R negotiations in every
country as early as possible, and to consider delaying the process only when a
detrimental effect in another important market becomes apparent. This can be done very
well with a simple scoring model, as it is an iterative process – all automated models
that simulate the optimal launch sequence beforehand should be viewed with caution.
This is particularly the case where ‘tricks’ might be used, for example in Portugal,
where the reference countries are Spain, France and Italy but where one of these three is
sufficient to set a price without having to update it when the other two basket countries
set their (perhaps lower) prices.
It is certainly easy to say that small markets should be used as buffers for the large ones.
The reverse – making sacrifices in a top-five market for gains in smaller countries –
would be difficult to justify, yet it may become an option in the case of France,
notorious for its low-priced, high-volume market and its use as a reference by many
other European countries.

Figure 11.2 Average time intervals between submission of the P&R
dossier and the awarding of pricing and reimbursement
permission
0 100 200 300 400 500 600 700
Belgium
Portugal
Austria
Greece
Finland
France
Norway
Italy
Spain
Netherlands
Switzerland
Denmark
Sweden
Ireland
Average time (days)
Source: Cambridge Pharma Consultancy
About the author
Roland Pfeiffer joined Altana Pharma in February 2000. He was appointed Integration
Manager for Europe in June 2001 and is focused on setting up structures and processes
including business planning, pricing and reimbursement issues. Before Altana he worked
for an international management consultancy for a year. He holds a Master of Science, a
PhD in biochemistry and a BA in business administration.

CHAPTER 12
Schering’s policy for pharmaceutical price harmonisation in
Europe
Michael Bohn, Head of Price Policy & Controlling Europe, Schering AG
(Germany)
Article summary
The control of pharmaceutical prices in the European market by national
authorities pressures company margins, encourages parallel trade and may be
contributing to the decline of the local pharmaceutical industry in comparison
with the US. German company Schering AG has adopted a centralised
approach to price setting, with overall European profits more important than
country-level turnover. By launching new products in careful sequence and
keeping prices within a narrow corridor all under head office control, Schering
aims to reduce losses through exchange-rate fluctuations and parallel imports.
Keywords
Centralisation, Free Pricing, Parallel Trade, Schering
SINCE THE BEGINNING of the 1990s, drastic cost-saving measures have been the
order of the day for national health systems in Europe. However, much of the focus for
savings has been on pharmaceuticals, despite the fact that, on average, they account for
no more than 10–15% of total national healthcare costs. It is, of course, legitimate to
subject the consumption of medicines to some regulation, but all too often
pharmaceutical consumption is not controlled to the corresponding permitted indication
but by health authorities intervening in European free-market competition.
Pharmaceutical companies, like all other companies, compete in a free market, but they
are denied one key element of free competition: free price setting in the market. This is
an untenable state of affairs, since the European pharmaceuticals industry is one of the
backbones of the export economy, with an extremely strong value creation capability.
The European pharmaceuticals market may be the second largest in the world (see
Table 12.1) but there is an increasing demand to adapt the market conditions to free
competition.
Is Europe fit to compete in a global market?
There are some key questions about why pharmaceutical companies make investment
decisions. For example: what is the role of European nations in a global marketplace? The
answer is that investment decisions in pharmaceutical research are driven, in large part, by
three factors: the quality of science, the quality of scientists, and the broader environment
in which innovation and reward combine for progress. Europe is strong in its science and
the quality of its scientists, but a question-mark hangs over the broader environment.

Table 12.1 World pharmaceutical market, 2001
Area €m Percentage of market
US + Canada 18 602
EU 66 22
Japan 47 15
Mexico/Brazil 10 3
Total 30 1005
Source: IMS Health
A study published recently in Scrip magazine suggested that, in contrast to countries with
price controls, patients who live in free markets get better medicines sooner. Physicians who
practise in free markets get more thorough information, more quickly, and nations that
maintain a free market for healthcare enjoy a level of pharmaceutical investment much
higher than nations that do not. In other words, a nation is economically stronger, its science
more robust, its people better cared for, when that nation’s government opens itself to the
forces of the free market. Unsurprisingly, R&D investment tracks a parallel line. However, a
close look shows that while R&D spending in Germany has doubled since 1987, most of
that doubling occurred by 1992. The past 10 years of price cuts (5% in 2001) have been
spent recouping investment that was lost after the short-lived and unsuccessful experiment
with physician drug budgets, price control and the impact of parallel trade.
Over the same period, pharmaceutical R&D spending in the US increased fivefold – the
results are now starting to show, with the bulk of top-selling drugs now researched in
the US (see Table 12.2)
Price regulation and free trade
Price regulation is to be found in a particularly well-defined form in those European
countries with a low GNP and correspondingly low budgets for healthcare. The result: lower
prices than in the originator countries. Figure 12.1 shows the wide range of pharmaceutical
prices in Europe, where the highest average is 2.3 times more than the lowest.
The key reasons for these differences are the authorities’ interference in pricing and the
difficulties in adjusting prices in line with inflation or fluctuations in exchange rates.
The enforced acceptance of low prices effectively constitutes a European solidarity
contribution by the pharmaceutical industry for countries that cannot afford the research
but are able at least to bear the marginal costs. The positive effect is that the poorer
countries are not excluded from using innovative pharmaceuticals, the negative effect is
that some arbitrageurs exploit these price differences and EU free trade, and re-import
the drugs into high-priced countries.
Table 12.2 Results of a free-market environment in pharmaceuticals.
Originator area for the 50 top-selling products
1988 1998 2003
19 US 32 US ?
28 Europe 14 Europe ?
Source: Schering AG

SCHERING’S PRICING POLICY IN EUROPE
Figure 12.1 Different price levels of pharmaceuticals in Europe (ex-
manufacturer prices, 1998, index based on official
exchange rates, D = 100)
177
135 134 133 128 124 123 122 117
109 109 108
100
88 85
0
50
1 00
1 50
2 00
CH GB FIN IRL B NL L DK I F P A D E GR
Source: Schering AG, VFA Statistics (BASYS)
This results not only in lost sales in the re-import countries, but also in greater pressure
on the whole European price structure. The consequence is that the lack of profit
margins also results in cutbacks in research expenditure and a refocusing of research
efforts on projects for fast-selling drugs in limited markets that guarantee a pay-back.
The euro and invisible price transparency
As a supplier of innovative prescription-only drugs, Schering AG is particularly affected
by these market distortions. Schering is a publicly traded company and is committed to
free markets and shareholder value. The administration of drug prices by the health
authorities obstructs the free pricing of pharmaceuticals and increases the risk of re-
imports (parallel trade) penalising the company by reducing margins.
The re-imports are defended by the European Commission with an eye on the eagerly
sought free goods trade, but at the same time the key competition element – free-market
price formation – is obstructed due to budget forces within national health systems.
Price management and launch strategies
As the territorial guardians of healthcare within European states, the national health
authorities are failing spectacularly in their roles. Instead of concerning themselves with
care and lack of care, they intervene in the free competition guaranteed by the Treaties
of Rome and price regulation. In Europe there are more regulation-directed price
changes of drugs than price adjustments by the manufacturers due to changed market
conditions. The ever-growing health spending shows that interventions in the pricing of
medicines have so far not resulted in worthwhile savings. The increased price
transparency between EU member states as a result of the euro’s introduction will lead
to even more intense price comparison. In the long run, it is not the ‘market prices’ but
the ‘prices administered’ by the national health authorities that are compared. It is
doubtful, for instance, whether the price of a Schering product in the French

reimbursement system represents the correct reference, in terms of economic and health
policy, for the Italian reimbursement system.
Schering’s pan-European policies
Without a free price structure between suppliers in the various health systems, Schering
is having to adopt a pan-European, rather than local, pricing strategy. The company now
sets a European standard price and coordinates a product’s launch sequence centrally.
This does curb the entrepreneurial freedom of national business managers, and product
introduction no longer depends on which country authorities admit the product the
quickest but rather on where the best price can be achieved.
For example, rapid market entry in Spain but at the ‘wrong’ price would be an
economically unsatisfactory example for all other countries that wanted to launch
afterwards. Pan-European price policy allows sufficient latitude for local price
management and also uses a marketing strategy tailored to local conditions. For example,
a bottle instead of a pre-filled syringe ready for use is supplied to countries with a lower
price limit, and the modern pre-filled ready-to-use syringes to countries with a higher
price. Essentially the client (health insurance authorities etc.) determines the whole
package (the cluster of value of the product) and hence also the acceptable national price.
Pan-European price policy
Despite the introduction of the euro, price differences still exist between Schering
products already on the market. However, for new products Schering hopes it will be
increasingly difficult for health authorities to argue why, in a single market, with a
standard currency, allowing free movement of goods, different supply prices have to be
accepted. In the EMU market, Schering is aiming for a standard euro list price for a
product. Naturally, the terms of trade may vary (discounts for large purchasers etc.) and
the prices to the public will be different because of country-level differences in
wholesaler/pharmacy trade margins and VAT rates. However, the manufacturer’s
selling price, for which Schering is responsible, is defined uniformly or established in a
narrow price range.
Figure 12.2 The optimal launch sequence
P x
B x
1. wave 2. wave 1. wave 2. wave
x
x
D x x
F x
ITA x x
E x
UK x x
x
x
A x
CH x x
NL x x
S x x
x
S
I
M
U
L
T
A
N
E
O
U
S
L
Y
S
I
M
U
L
T
A
N
E
O
U
S
L
Y
Price decision rice/Trade name dissemination rice application/setting LaunchP P
Source: Schering AG

SCHERING’S PRICING POLICY IN EUROPE
Schering now has a corporate objective of setting the euro price, with significant
advantages to the company. For new products, a standard euro price will be defined,
either inside or outside national health service reimbursement schemes. Older products
will be continuously transferred to a narrower euro price range, which should deter
parallel importers. The result should be increasing harmonisation of European
pharmaceutical prices in those major manufacturing countries that can afford the
research. At the same time, however, it should enable those countries with high
additional payments only (without health service reimbursement) to have access to
innovative medicines.
In the medium term, the increased competition will result in benefits for German
(pharmaceutical) industry: Schering has innovative products capable of competing, and
possesses the necessary logistics know-how to deal with the EMU. Production,
marketing and sales operations are organised in a pan-European manner. If a local
subsidiary does not obtain this price at a national level the product will not be launched.
Market prices defined purely by national market conditions belong to the past.
Head office control
The above-mentioned price approval process requires discipline at a local office level.
An adjustment of the list price (up or down) always needs head office agreement. When
raising prices, Schering must take into account the higher margin against the possible
losses due to parallel imports. All top-selling products’ minimum euro prices are
defined and must not be undercut by local business managers. Target prices are defined
for some old products, particularly those with a relatively wide price range. The present
national list prices virtually form the European price range, the lower limit of which is
the minimum price. This is undercut only in exceptional cases, for example if the
country is not a reference country for other countries in the EMU.
There have been some problems with the introduction of this centralised pricing
structure, particularly the disempowering of country managers. Today, however,
discipline prevails, together with a corresponding acceptance, even though regional
bosses can often introduce the minimum price only after strenuous efforts with the
authorities. The reason for this acceptance lies in increased pan-European (price)
competence, and the outcome is improved financial performance in the form of
Schering’s increased European profitability. This is important also for national margins
with regard to the pan-European incentive scheme.
About the author
Michael Bohn is Head of Price Policy & Controlling Europe, Schering AG. Past posts
include Finance and Controlling, Project leader Asia for corporate Controlling &
Reporting, Head of Planning & Controlling and Head of Pricing Policy in
Europe/Marketing and Business Development. Mr Bohn graduated in Economics.

CHAPTER 13
Bio-pharmaceutical prices and the effects on the US economy
Roger A. Edwards, Haleh Armian-Hawley and Louise Firth, TIAX LLC (US)
Article summary
TIAX studied the impact of market-based pricing patterns in the US on bio-
pharmaceutical innovation and related economic contributions. The study
concluded that the sector contributes greatly to the economy and argues that
pharmaceutical prices should remain high to support continued investment in R&D.
Keywords
Biotechnology, Economy, IMPLAN, Innovation, Jensen’s, R&D, TIAX, US
THE PHARMACEUTICAL SECTOR contributed $229.2bn in sales, $75.4bn in labour
income and nearly 1.1 million employees to the US economy in 1999. Existence of a
market-based pricing environment in the US has been a critical driver to the creation of
bio-pharmaceutical innovation and its associated economic benefits.
In 2002, TIAX LLC completed a study entitled ‘Examining the Relationship between
Market-based Pricing and Bio-pharmaceutical Innovation’, which investigated the
impact of market-based pricing patterns in the US on bio-pharmaceutical innovation and
related economic contributions. The study concluded the following:
Contrary to widespread belief, the pharmaceutical sector does not experience a
high rate of risk-adjusted return.
The pharmaceutical sector has maintained an alignment of industry returns with associated
risk. Using Jensen’s alpha,8
the recognised investment-measurement tool, the TIAX team
evaluated the industry’s relationship between risk and return relative to the cost of capital
adjusted for risk. The team analysed the risk-adjusted returns for the period 1991–2000
and found them to be similar to those in the 1981–99 period. A 1993 study by the US
Office of Technology Assessment determined that the 1981–90 rate of return in the
pharmaceutical sector was 2–3% above the cost of capital (Office of Technology
Assessment, Congress of the United States, 1993). In conjunction with this study, our
findings confirm that industry returns were aligned with risk throughout the 1990s.
8
Jensen’s alpha has been widely used to measure whether returns on a portfolio of stocks exceed the
expected cost of capital as measured by the Capital Asset Pricing Model (CAPM). A low Jensen’s
alpha suggests low differential return above the cost of capital. Based on monthly stock return data,
Jensen’s alpha for the pharmaceutical industry in the 1980s was 0.65% and in the 1990s was 0.73%.
Jensen’s alpha is an important measurement of mutual fund and stock portfolio performance and is
explained in many finance texts (see Bodie, 2001; Elton and Gruben, 1995; Sharpe, 2000).

• The industry’s risk-adjusted return is lower than that of other R&D-based
industries, such as computer network and software service sectors.
The bio-pharmaceutical sector contributed to the US economy in terms of:
• providing employment and revenue
• comprising a notable portion of the US stock market value.
This article describes in detail the supporting analyses related to the second finding. It
discusses the economic benefits derived from the bio-pharmaceutical sector and briefly
addresses some related background issues.
Background
The price of bio-pharmaceutical innovation affects everyone in the US from patients
and physicians/providers, to payers/employers and policy makers/legislators. As the
largest market in the world and as the only remaining major country with a market-
based system, the US occupies a unique position. Nearly all pharmaceutical and
biotechnology firms worldwide seek to launch their products in the US, making it the
epicentre of global innovation. The US is likewise the world’s meeting ground for
pharmaceutical intellectual capital. But while the US is the leader in the development of
new breakthrough drugs for the rest of the world, this level of innovation does not come
cheaply. It places a huge financial burden not only on US employees and retirees but
also on payers and employers, because the price covers more than just the direct
production of medication itself. It also includes the level of innovation behind that
particular therapy – not to mention the hugely expensive efforts that went into the
development of other drugs that ultimately failed to make it to the market. According to
the Tufts Center for the Study of Drug Development, the cost of developing a new drug
now averages $802m and it takes 10–15 years to bring that drug to market.9
Of every
5,000 medicines tested, only one is eventually approved for patient use (PhRMA, 2001).
‘The price of innovation, in terms of R&D costs, is borne worldwide almost exclusively
by the U.S. private insurance and out-of-pocket markets’, said a leading healthcare
ethicist. ‘And the drug companies correctly point out that innovation is expensive, but
the burden of paying for it is completely misplaced.’
Just how much does the US spend on prescription drugs? The nation devotes just 1.4%
of its GDP to pharmaceutical expenditures, which is about average among the major
industrialised nations. While pharmaceuticals currently represent about 10% of total
healthcare costs in the US, this is not a new phenomenon as the rate has fluctuated
between 4% and 10% for the past four decades10
(see Figure 13.1 and Table 13.1). Drug
expenditures, however, have increased at a compound annual growth rate of 9% since
1996.
9
‘The full capitalized resource cost of new drug development was estimated to be $802 million
(2000 dollars). This estimate accounts for the cost of failures, including research compounds
abandoned during development, as well as opportunity costs of incurring R&D expenditures
before earning any returns’ (Tufts Center for the Study of Drug Development, 2001).
10
CMS url: www.hcfa.gov/stats/NHE-Proj/

BIO-PHARMACEUTICAL PRICES AND THE US ECONOMY
Figure 13.1 Pharmaceutical expenditures worldwide and percentage of
US health spending on pharmaceuticals, 1960–2001
22%
22%
17%
16%
13%
10%
9%
8%
0% 5% 10% 15% 20% 25%
Fra nce
Italy
Jap an
UK
Germ any
US
Denm ark
Switzerla nd
Source: OECD (2001)
Table 13.1 US drugs as a percentage of healthcare costs
1996 1997 1998 1999 2000 2001
6.5 6.9 7.4 8.2 8.9 9.8
Source: Health Care Financing Administration
Drug expenditures and growth in expenditures have been driven by volume, more
than price. A study that analysed trends in drug spending found substantial increases
in seven disease/drug categories ranging from 43% to 219% during the 3-year
observation period (Dubois et al., 2001). Although the average transaction price rose
in every case but one, the impact of price on the rise in drug spending was greatly
exceeded by the growth in medication volume.
Without doubt, increased drug utilisation plays a major role in the growth of
pharmaceutical expenditures. An ageing, and often less healthy, population has sent
the demand for arthritis, cardiovascular and diabetes medications soaring. Drugs are
now available that often preclude the need for hospital admission and expensive
treatments.
Pharmaceutical R&D investments
An often overlooked fact is the major role that US pharmaceutical companies play in
funding worldwide R&D. As demonstrated in Figure 13.2, US pharmaceutical
companies provided $20.3bn or 67% of worldwide private pharmaceutical funding in
1998. In addition, US companies funded $19.5bn, which accounted for 57% of
worldwide public funding for health R&D that same year.

Figure 13.2 Worldwide private and public R&D funding for healthcare
P rivate Not-for-Pr ofit
F unding
$6.0bn
8%
Public Fu nding:
Deve lo ping
Co untries
$2.5bn
3%
1998d T otal
(cu rrent US $)
$ 73.5bn
US P harm a
Companies F unded
$20.3bn or
67% of
W or ldwide T otal
Pha rma Indu stry
F unding
US Public F unding
$19.53bn or
57% of
W or ldwide T otal
Public F unding
Public F unding:b
A dvanced Tr ansition
Co untries
$ 34.5bn
4 7%
P rivate F unding:a
Phar maceutical
In dustry
$ 30.5bn
4 2%
Non-US
USc Non-US
US
a
Pharmaceutical firms, private non-profit organisations, academic/research institutes,
hospitals/laboratories, NGOs.
b
Government departments (national aid agencies), academic/research institutes, hospitals.
c
US pharmaceutical companies private funding worldwide.
d
1998 is the latest year in which public and private data are available worldwide.
Source: Global Forum for Health Research/WHO, Monitoring Financial Flows for Health Research, 2001
Public R&D efforts, which are largely basic research, would not lead to marketable
products without private R&D capabilities and support (e.g. clinical trials, distribution).
The private sector plays a vital role in translating knowledge about diseases into final
therapeutic products for patients. This public–private partnership in the US has been
well recognised for over two decades, beginning with the Stevenson–Wydler Act (1980)
and Bayh–Dole Act (1980) and continuing with the Federal Technology Transfer Act
(1986), National Technology Transfer and Advancement Act (1995), and the
Technology Transfer Commercialisation Act (2000). For example, NIH’s Office of
Technology Transfer states as its goals11
to: ‘benefit the public health, attack disease on
multiple fronts, attract new R&D resources, obtain return on public investment, and
stimulate economic development’. In addition, the existence of basic research in the
private sector provides further stimulus to public research through scientific exchange at
professional conferences, peer-reviewed periodicals and public debate.
There is a significant time lag between scientific discovery and the creation of a useful
therapeutic drug. The estimates also suggest that the lag between funding and
commercialisation is 17–19 years, and support the hypothesis that the contribution of
public science to new technological opportunities comes in the earliest stages of
pharmaceutical discovery (Toole, 1999).
Genomics, transcriptomics and proteomics are especially dependent upon this
partnership because of the critical role that the private sector plays in applying
knowledge from these types of research into useful therapies (see Figure 13.3).
11
Presentation by M. Rohrbaugh, Acting Director, Office of Technology Transfer, NIH, 2002.

Figure 13.3 Worldwide genomics research investments, 2000
$0
$500
$1,000
$1,500
$2,000
$2,500
Government & Non-
profit
Publi cly traded
Genomics Firms
Publi cly traded
Pharma Biotech
US$m
$1, 805
$2, 061
$900
Publ ic
Sector
32%
Private
Sector
68%
(Publicly
traded and
privately
held)
a
a
a
$800m to $1bn range.
Note: inclusion of privately held firms would add another $0.5–1bn.
Source: World Survey of Funding for Genomics Research, Stanford-in-Washington Program, Robert
Cook-Degan, ‘Genomics R&D: some facts & figures’, Human Genome Discovery/TriGenome
Conference, February 2002, Santa Clara, California, USA.
A healthy, venture-capital-based entrepreneurial biotechnology industry has evolved in
the US as part of this public–private R&D partnership. According to the National
Venture Capital Association, about $3bn – or 8.2% – of the $36.5bn in venture capital
funding available in the US in 2001 went into biotechnology. In Europe, about half that
amount, or €1.7bn, went into similar research. The nature of the large, US market-based
pricing environment has supported not only domestic biotechnology entrepreneurship,
but also worldwide biotechnology entrepreneurship, though to a lesser extent.
Scherer (2001) has noted that ‘pharmaceutical industry R&D investments tend to
exceed risk-adjusted capital costs by only modest amounts’ and Lichtenberg (2001) has
further argued that the expectation of future profits greatly influences current R&D
spending. He concluded that ‘policies that threaten to diminish future profits will reduce
R&D investment today, even if they do not affect current profits’.
Bio-pharmaceutical Innovation
Innovation is truly in the eye of the beholder. It can be defined as running the gamut
from modest incremental novelty, such as a new drug-delivery mechanism, to the
creation of groundbreaking treatments that cure the underlying causes of disease. Bio-
pharmaceutical innovation is shaped and affected by complex global dimensions and
issues, represented by the interlocking puzzle pieces in Figure 13.4. The presence of
both market-based and regulated pricing systems, access to existing and future
innovation, health benefits of innovation, broader economic benefits to nations and
regions, industry returns, and R&D investments are all critical components in
innovation creation.

Figure 13.4 Worldwide components of the pricing and innovation
puzzle
Access to
Future
Pharma/Biotech
Innovation
Regulated
Pricing
System
Health Outcome
Benefits of
Pharma/Biotech
Innovation
MarketMarket--BasedBased
Pricing SystemPricing System
Access toAccess to
Existing HealthExisting Health
Care includingCare including
PharmaceuticalsPharmaceuticals
Pharma /
Biotech
R&D
Investments
Pharma /
Biotech
Industry Returns
Economic
Contributions
of Innovation
BioBio--PharmaceuticalPharmaceutical
InnovationInnovation
CreationCreation
Source: TIAX LLC
American patients are the beneficiaries of more new drug approvals than patients in any
other country in the world. From 1990 to 2000, the US launched 259 new drugs,
compared with Japan’s second-place showing of 151 new launches. The US likewise
launched 78 FDA priority-review drugs, compared with the UK, in second place with
36 (see Table 13.2).
The biotechnology industry has experienced staggering growth in the number of drugs
both in development and on the market. The healthcare benefits of investments in
biotechnology R&D in the 1990s could be seen in 2000 in a 370% growth in the
number of drugs in development, a 920% growth in the number of biotechnology drugs
on the market and a 600% growth in revenues (see Figure 13.5).
Table 13.2 Number of US launches of innovative medicines, 1990–
2000
Country Number of first launches
Number of first launches of FDA
priority-review drugs
a
US 259 78
Japan 151 9
UK 101 36
Germany 62 25
Italy 44 16
France 35 24
Econo
Contribu
of Innov
a
The decreases in FDA review times have also contributed to this advantage.
Source: Pharmaprojects, Drug Topics, TIAX LLC Analysis 2002

Figure 13.5 Biotechnology revenues, drugs on the market and drugs in
clinical trials
100
370
800
197
92
10
0
200
400
600
800
1, 000
1 990 2 000 2 00 5 Est .
B iot ec h d ru gs on t he m a rk e t
Biote c h d ru gs in c lin ica l s t ud ie s ( De v elop m e nt)
$ 3bn R even ue
$1 8bn R ev en ue
$5 0bn R ev en ueNumberofcompounds
Source: K.N. Gilpin, ‘The future beckons to biotech’s faithful’, New York Times, 17 February 2002
The economics–innovation relationship
Is innovation responsible for economic benefits? The accumulation and application of
new knowledge – cornerstones of innovation creation – are vital to economic growth.
Consider the experiences of Korea and Mexico. Korea poured its energy into
developing high technology while Mexico largely avoided investing in innovative
businesses, sticking instead to traditional agriculture and natural resources (e.g. silver
and oil) and businesses employing less-skilled labour. The numbers tell the story:
The average real wage in Korea grew ninefold from 1960 to 1990, while the
real minimum wage in Mexico stayed almost the same during the same time
period. Between 1990 and 1998, Korea’s real economic-growth rate was eight
times that of Mexico’s. (Enriquez, 2001)
merman, 2002)
It is clear that investment in education, new knowledge, and innovation is fundamental
to substantial economic well-being. It is also clear how fast a country or region can lose
the economic advantage associated with innovation:
In just a decade, the balance of research power and investment has shifted
dramatically from Europe to the U.S., sending a frightening signal to the EU.
Those and hundreds of smaller investment decisions have deflated Europe’s
pre-eminence as a scientific powerhouse over the past decade. In 2000,
Europe attracted only 70 percent of the $24.3 billion in pharmaceutical-
research investment that the U.S. did, a direct reverse of their portions of
research dollars in 1990. (Fuhrmans and Zim
The EU ‘High Level Group on Innovation and Provision of Medicines, G10 Medicines
Report 26 Feb, 2002’ recommended finding ‘the right balance between health objectives

and industry competitiveness’. Stimulating innovation and improving the EU science
base is another important goal asserted by the report.
Like the high-technology industries of the 1980s and 1990s, the pharmaceutical and
biotechnology industries are perfectly positioned to be significant contributors to
economic well-being in the coming decades by leveraging the new genomic,
transcriptomic and proteomic knowledge being created by scientific achievements.
Findings: US economic contributions
Significant economic benefits accrue to environments with strong pharmaceutical and
biotechnology businesses. In our post-industrial economy, pharmaceutical and
biotechnology sectors form a foundation for building and maintaining a strong
economy. We examined the economic contributions derived from the pharmaceutical
and biotechnology sectors under a market-based pricing system and found that:
• the pharmaceutical sector contributes significantly in terms of direct, indirect and
induced impact on sales, labour income and employment
• the biotechnology sector provides employment and revenue generation
• the pharmaceutical and biotechnology sectors comprise a notable portion of the US
stock market value.
The pharmaceutical sector contributed $229.2bn in sales and $75.4bn in labour income
and employed nearly 1.1 million in 1999. We examined contributions to the economy
derived from a market-based pricing environment in terms of direct, indirect and
induced impact on sales, labour income and employment. In estimating this impact for
the pharmaceutical industry, we used an input–output model known as IMPLAN.12
IMPLAN’s multipliers for the ‘pharmaceuticals industry’ (SIC code 283) include four
subgroups: medicinal chemicals and botanical products, pharmaceutical preparations, in
vitro and in vivo diagnostic substances, and biological products excluding diagnostic
substances.
Direct impact consists of sales (revenue), labour income, employment and total value-
added contributions attributed directly to the sector. Indirect impact refers to the goods
and services that the sector purchases from other industries, such as equipment
manufacturers, and induced impact measures the purchases made by employees in the
industry. Of that $229.2bn, $101.5bn was in direct sales, $57.8bn was in indirect sales
and $69.9bn was in induced sales. The pharmaceutical sector also employed a total of
nearly 1.1 million people through direct, indirect and induced means, for a total of more
than $75bn in labour income (see Figure 13.6).
12
IMPLAN (www.implan.com) describes commodity flow from producers to intermediate and
final consumers. In the input–output model, multipliers are derived mathematically that describe
the change in output for each and every industry as a result of producing $1 of final demand. The
notion of a multiplier rests upon the difference between the initial (direct) effect of a change in
final demand and the total effects (direct, indirect and induced) of that change. The US revenue
and employment numbers shown in the PhRMA Annual Membership Survey are used as the
proxy for production output of the pharmaceutical industry.

Figure 13.6 Total economic impact of the pharmaceutical sector, 1999
101.50
30.10
59.70
57.8
21.1
33.1
69.9
24.2
41.6
0
50
100
150
200
250
Sales Labour Income Total Value Added
$bn
Source: 1999 IMPLAN reports, PhRMA and TIAX LLC Analysis 2002
Total value added includes four sub-components: (i) employee compensation; (ii)
proprietary income, which is payments received by self-employed individuals as
income; (iii) other property-type income, such as payments from rents, royalties and
dividends (this includes corporate profits and payments to individuals in the form of
corporate dividends, rents received on property and royalties from contracts); and (iv)
indirect business taxes, which consist primarily of excise and sales taxes paid by
individuals to businesses.
Based on IMPLAN, we found that the pharmaceutical sector bought approximately
$58bn in goods and services from other industries during 1999 (indirect effect). In
addition, people employed in the pharmaceutical sector purchased nearly $70bn in
goods and services (induced effect) (see Figure 13.7).
The US biotechnology industry provides employment as well as revenue generation.
State politicians and leaders throughout the US are trying to boost their regional
economies by attracting state-of-the art industries, such as biotechnology. New England
and California have significant biotechnology hubs that return money and resources
back into their economies (see Table 13.3). These regions have well-educated labour
forces and access to universities and hospitals.
Table 13.3 US biotechnology industry characteristics by selected
regions, 2000
Region
Number of
public
companies
Market cap.,
30 June
2001 ($m)
Number of
employees
(000s)
Revenue
($m)
Market cap.
per
employee
(000s)
San Francisco Bay 76 92,168.20 26,464 5,851.40 3.48
New England 48 53,575.20 20,641 3,069.90 2.59
San Diego 31 23,272.10 7,976 874.00 2.91
New Jersey 21 10,591.70 3,556 549.90 2.97
Mid-Atlantic 19 22,240.20 3,871 769.00 5.74
Pacific Northwest 19 17,189.60 3,258 1,096.60 5.27
Source: Ernst & Young, 2000 and TIAX LLC Analysis, 2002

Figure 13.7 Total pharmaceutical industry economic contributions by
type, 1999
$101.5bn
211,671
$30.1bn
$59.7bn
Sales (Revenue)
Employment
Labour Income
Total Value Added
PharmaceuticalPharmaceutical
IndustryIndustry DirectDirect
ImpactImpact
IndustryIndustry
InducedInduced ImpactImpact
IndustryIndustry
IndirectIndirect ImpactImpact
$
Purchases
Goods,
Services, Etc.
$
Purchases
Goods,
Services, Etc.
$
Purchases
Goods,
Services, Etc.
$57.8bn
313,855
$21.1bn
$33.1bn
Sales (Revenue)
Employment
Labour Income
Total Value Added
$69.9bn
557,512
$24.2bn
$41.6bn
Sales (Revenue)
Employment
Labour Income
Total Value Added
Source: 1999 IMPLAN reports, PhRMA and TIAX LLC Analysis 2002
Pharmaceutical and biotechnology sectors comprise a notable portion of the US stock
market value. We calculated the market capitalisation of the pharmaceutical and
biotechnology sectors against the total US market value as measured by the aggregation
of NYSE, NASDAQ and AMEX stocks. We found that from 1990 to 2000 the market
capitalisation of the pharmaceutical/biotechnology sectors averaged 9% of the total
market value. By 2001, that share had risen to nearly 12% (see Figure 13.8).
Figure 13.8 Market capitalisation of pharmaceutical and biotechnology
sectors as percentages of total market value, 1990–2000a
0%
2%
4%
6%
8%
10%
12%
14%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
a
The total US market is defined as the aggregation of NYSE, NASDAQ and AMEX stocks.
Source: Datastream and TIAX LLC Analysis 2002

Conclusions and implications
TIAX believes that there would be a decline in R&D spending, stock prices and
venture-capital funding in the bio-pharmaceutical sector if there were price
interventions in the US. As the world’s largest and only remaining market-based pricing
environment, the US has emerged as the global leader in innovative drugs with more
new product launches than all other countries combined. The US biotechnology
industry likewise surpasses the rest of the world in terms of drugs under development.
Furthermore, the value of public R&D funding might be diminished if private R&D
funding is weakened, which means that new, gene-based knowledge might not be
translated into useful therapeutics.
Significant economic benefits accrue in environments with strong bio-pharmaceutical
entities, including forming a foundation for building and maintaining a strong economy.
Under a market-based pricing system, the pharmaceutical and biotechnology sectors
provide economic contributions in terms of revenue generation and employment.
Additional primary data regarding the economic spill-over benefits need to be collected
across countries so that we can better understand the economic contributions of
companies that are striving to use the latest pharmaceutical sciences and biotechnology
knowledge. Thorough multinational comparisons of bio-pharmaceutical pricing systems
and innovation creation and diffusion are needed to evaluate how market-based pricing
will affect future bio-pharmaceutical innovation investment and associated economic
benefits.
Acknowledgements
The study ‘Examining the Relationship between Market-based Pricing and Bio-
pharmaceutical Innovation’ was made possible by Aventis, the John F. Kennedy School
of Government at Harvard University, JP Morgan, the New York State Office of
Science, Technology & Academic Research (NYSTAR), Pfizer, Pharmacia, Stanford
University, and Wyeth.
For a copy of the full report, please contact the authors below. The study provides
further discussion and supporting analyses on the overall findings.
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About the authors
Dr Edwards is a Director in TIAX’s Life Sciences business. His prior work includes over
two decades of experience in industry, academia and government in the diffusion of
medical innovations. Dr Edwards holds an AB in Human Biology and an MS from
Stanford University along with an ScD from the Harvard School of Public Health. He is
co-inventor on one patent, co-author of 11 journal articles and three book chapters, and
has made over 60 professional presentations in the health, medical and technology
fields.

Ms Armian-Hawley is Senior Manager in the Life Sciences group and has worked on a
wide range of biomedical/life science projects during the past decade. Her interests are
in strategic planning, market and technology assessments, and policy for the bio-
pharmaceutical and medical device/supplies industries. Ms Armian-Hawley received a
BS in Marketing and Finance from the Boston College School of Management and holds
an MS in Health Policy and Management from the Harvard School of Public Health.
Ms Firth is a Director in TIAX LLC’s Life Sciences business. She has over 20 years’
experience working with companies, government agencies and trade associations on
commercialisation of pharmaceuticals, diagnostics, medical devices and healthcare
services. Ms Firth holds an MS in Business Administration and an MA in
microeconomics, both from Northeastern University. Her publications include articles in
journals, the trade press, monographs and a book chapter. She has presented the
results of her work before the public, trade groups, government agencies, arbitrators and
courts.
Roger A. Edwards, ScD, Director, Life Sciences, TIAX LLC. Tel: +1 (617) 498 5032;
email: edwards.roger@tiax.biz
Haleh Armian-Hawley, MS, Senior Manager, Life Sciences, TIAX LLC. Tel: +1 (617) 498
6462; email: hawley.h@tiax.biz
Louise Firth, MS, Director, Life Sciences, TIAX LLC. Tel: +1 (617) 498 5937; email:
firth.l@tiax.biz

CHAPTER 14
Differential pricing in the EU: the significance of the decision
in the GlaxoSmithKline case
Lorna Brazell, Partner, Bird & Bird (UK)
Article summary
In 2001, GlaxoSmithKline was ordered by the European Commission to stop its
dual-pricing system for Spanish wholesalers which contravened the free-market
philosophy that underlies the EU. The case attracted a great deal of attention
because it was the first time a pharmaceutical company had tried to justify
differential pricing because of economic distortions in the market resulting from
the differences in national pharmaceutical pricing and reimbursement regimes.
This article reviews Glaxo’s defence and the Commission’s opinion.
Keywords
European Court of Justice, GlaxoWellcome, Parallel Trade, Spain, UK
PARALLEL TRADE OF prescription drugs within the EU increased from 0.5% in 1985
to 2% of total sales in 1997. The causes were the regulatory framework in member
states, and also currency fluctuations – in particular sterling – which appreciated by
27% between January 1996 and December 1998. As a result of these factors,
pharmaceutical companies’ products are sold at widely different prices in the different
member states. The greatest divergence in prices is between the low prices set in France,
Spain and Greece and the high prices payable in the UK (20% above the ‘European
average prices’), Denmark and The Netherlands.
In addition, measures encouraging parallel imports are commonplace. In the UK, a
pharmacist receives the manufacturer’s list price less a 4–5% ‘claw-back’ – irrespective
of the price actually paid. In Denmark, a pharmacist has a legal obligation to inform the
patient of all cheaper substitutes available. In Sweden and Germany, the authorities
recommend that pharmacists sell the cheapest products.
Not surprisingly, the pharmaceutical companies have been driven to try to limit parallel
trade in their products, to avoid having their profits in the higher priced markets
undercut by an increasing stream of cheaper imports from the lower priced markets.
In the October 2000 Bayer-Adalat case, the Court of First Instance of the European
Court of Justice (ECJ) held that restrictions of supply imposed by a pharmaceutical
company to hinder parallel imports of pharmaceutical products between member states
do not fall foul of EC competition rules provided that they are

• not adopted pursuant to a concurrence of wills between the manufacturer and the
domestic suppliers (contrary to Article 81(1) of the Treaty of Rome), and
• not an abuse of a dominant position (contrary to Article 82).
At the same time as the Bayer case was being considered by the ECJ, the European
Commission was investigating a 1998 agreement between GlaxoWellcome and Spanish
wholesalers. The agreement stated that sales of GlaxoWellcome’s products to the
wholesalers would be priced up to the ‘maximum industrial price’ (set by the Spanish
authorities) if the products were for resale in Spain, but permitted a higher price to be
charged if they were for export.13
The higher price was in fact an index-linked version
of the price originally proposed to the Spanish authorities to be charged for these
exportable products. The effect, if the agreement were implemented, would be to reduce
the number of products which were on sale in Spain at a price sufficiently below that in
other member states to make parallel exporting to other member states commercially
attractive.
Glaxo refused to supply those wholesalers that did not sign up, and oversaw those that
had. This it did by receiving information about illicit exports by wholesalers who had
accepted the agreement but were not abiding by it, from disgruntled wholesalers who
were sticking to the bargain; and monitoring volume bought at Clause 4A price and
comparing it with IMS data for purchasers’ domestic sales. When both of these proved
insufficient to stop excess quantities finding their way into the Spanish market for
export, Glaxo started supplying wholesalers with quantities based not on what they had
ordered but on historic data. This led to a complaint to the Spanish competition
13
Clause 4A of the GlaxoWellcome agreement with Spanish wholesalers
icle 100 of Law 25.1990
that the aforementioned pharmaceutical products are financed by the funds of the
lause 4B:
In the absence of one of these two factors (i.e. in all cases where Spanish law gives full
Pursuant to the provisions of subsections 1 (first paragraph) and 2 (of Art
of 20 December 1990) concerning medicine, the price of pharmaceutical products of GW SA and
its subsidiary companies shall, in no event, exceed the maximum industrial price, established by
the Spanish health authorities when the two factors which allow for the application of the said
legal rules are present, namely:
Spanish social security or by Spanish public funds; and that the acquired
pharmaceutical products are subsequently marketed at a national level i.e. through
pharmacies or Spanish hospitals.
C
freedom to the laboratories to set the prices of their pharmaceutical products
themselves), GW SA and its subsidiaries will fix the price of their pharmaceutical
products according to real, objective and non-discriminatory economic criteria and
completely irrespective of the destination of the product determined by the purchasing
warehouse. In particular, GW SA and its subsidiary companies will apply to their
pharmaceutical products the price which, on the basis of their internal economic
surveys, had been initially proposed to the Spanish health authorities and objectively
updated taking into account the increase in the cost of living in accordance with the
provisions of subsections 1 (first paragraph) and 2 (of Article 100 of Law 25.1990 of
20 December 1990) concerning medicine, and other prior Spanish legislation
concerning setting of prices of medicine.

GLAXO'S DUAL PRICING IN SPAIN
authorities, and the agreement was in fact suspended for most of the period of the
European investigation.
The investigation lasted over 3 years and involved submissions from a number of
interested parties including EFPIA (in support of GlaxoWellcome’s position) and the
Spanish wholesalers’ associations and EAEPC14
(arguing that the agreement was indeed
anti-competitive). In May 2001 the Commission announced that the agreement was
anti-competitive and could not be implemented.
The fact that the wholesalers had had the option of signing up to the agreement or not
meant that GlaxoWellcome could not argue that there was no concurrence of wills, as
Bayer had successfully done. Since there was an agreement, Article 81 of the Treaty of
Rome necessarily applied at that level at least. In fact most of the conditions for
application of Article 81(1) were not seriously contested: there was an agreement, and it
would have the effect of compartmentalising the common market. This latter is of
course the ill that the Treaty of Rome sets out to eliminate. Glaxo therefore had two
options. It could argue that the agreement was not anti-competitive within the sense of
Article 81(1) at all. Alternatively, it could argue that if the agreement were contrary to
Article 81(1), it should be exempted under Article 81(3). Naturally, Glaxo ran both sets
of arguments, making this the first case in which a pharmaceutical company has
attempted to justify obstacles to parallel imports on the basis of the economics.
Glaxo argued that its pricing system did not distort competition but merely remedied the
distortion of an otherwise level playing field that was imposed by member states
through their diverse regulation of reimbursement prices. Expanding on this theme,
Glaxo identified a conflict between UK policy, where the high reimbursement prices
allowed pharmaceutical companies to profit and thus promote further R&D, and the
Spanish policy, which was characterised as maintaining low prices to bring modern
healthcare within affordable reach. Allowing parallel trade, they argued, allowed the
(quite legitimate) Spanish policy to undermine the UK one.
The Commission was not impressed. The basic argument, that GlaxoWellcome was
entitled to try to remove distortions of competition imposed by member states, had
already been argued out in the 1995 Merck v. Primecrown15
decision of the ECJ. The
ECJ acknowledged that
although the imposition of price controls is indeed a factor which may, in
certain conditions, distort competition between Members States, that
circumstance cannot justify a derogation from the principle of free movement
of goods.
observed that
Member State must be remedied by measures taken by the Community
It
it is well settled that distortions caused by different price legislations in a
14
EAEPC is the professional body representing national associations and individual companies
engaged in the parallel trade and distribution of pharmaceuticals in the EU/European Economic
Area.
15
Joined Cases C-267 and C-268/95, [1996] ECR I-6285,

authorities and not by the adoption by another Member State of measures
incompatible with the rules of free movement.
GlaxoWellcome attempted to argue that what the case means is that the European
Commission, a Community authority, should take measures such as granting an
exemption for a field-levelling pricing scheme. Not so, according to the Commission.
The extent of policy conflict between the UK and Spain is overstated. Both set prices
based upon companies’ economic positions, including the need for R&D, since that is
expressly a factor which the pharmaceutical companies can take into account in the
economic report they submit. They held that there was no evidence that parallel trade
from Spain was influencing Glaxo’s R&D spend at all. At 2%, they said, parallel
imports are a minimal proportion of the whole market. Further, regardless of the
disparate pricing policies of Spain and the UK, Glaxo’s scheme restricts opportunities
for parallel trade resulting from currency movements – which everyone agreed was a
legitimate entrepreneurial activity. A detailed analysis of the trade figures showed that
40% of the ‘at risk’ products were traded less when the pricing scheme was in
operation, so the agreement did distort competition.
The impact of price negotiations with regulators
Glaxo also came up with the ingenious argument that the arrangement it proposed did
not amount to a dual-pricing scheme since one of the two prices or price bands was
simply that set by the Spanish regulators. This was an important point of principle in
view of the case law. The Court of Justice (and Court of First Instance) has always
qualified agreements containing export bans, dual-pricing systems or other limitations
of parallel trade as restricting competition ‘by object’. That is to say, such a scheme is
prohibited by Article 81(1) per se, without there being any need for an assessment of
their actual effects. In principle they are not eligible for exemption pursuant to Article
81(3). If the agreement did not have the object of distorting competition, then the
Commission would need to review the actual effect of the scheme carefully before
concluding that it was prohibited.
In the event, the Commission found the argument unconvincing. The Spanish regulators
set reimbursement prices only following negotiations with the producer, which start
with the producer supplying technical and financial details of the product, including the
R&D costs, and a proposed price. Even once a price has been fixed, it can be adjusted at
any time on application if a change is justified based upon changes in public health,
technical, business or budgetary circumstances. In fact, GlaxoWellcome had made
applications for price increases for several of its products identified as most at risk from
parallel imports, and had succeeded in getting the reimbursement prices increased by
between 15% and 40% (although in part by accepting a price reduction for Zantac – but
then, as the Commission pointed out, Zantac was about to come off patent so its price
would have been undercut by generic competition anyway). By the time of the decision,
the Spanish prices of the majority of the ‘at risk’ products were 85–90% of the average
prices across the European Community. This strongly suggests that GlaxoWellcome had
a significant role in setting the maximum industrial prices.
The Commission took the view that a pricing policy which makes it economically
uninteresting for wholesalers to indulge in parallel trade must be considered to be at

least as effective as an outright contractual export ban in excluding such trade because it
involves, in principle, no cost of monitoring compliance. Accordingly, the Commission
held that the agreement did fall within the Article 81(1) prohibition.
In theory, Glaxo’s ability to use its ‘not a dual-pricing scheme’ argument might have
been improved had it not participated in the discussions with the regulators. In that case
the Commission would have had a harder time arguing that Glaxo had a hand in setting
the Spanish prices and this ‘it is as good as a dual-pricing scheme even if it isn’t
actually one’ position might not have been justified. In practice this was not an option,
as in order to be able to market the product in Spain a reimbursement price needs to be
set and the law requires the regulator to produce an economic report which would be
impossible without input from the manufacturer. The half-way alternative of providing
the information for the initial report but taking no part thereafter –not applying for any
adjustments, for example – would probably have materially worsened the commercial
position and is unlikely to have been sufficiently distinct to change the Commission’s
finding, which was based on the object of the proposed agreement and not the details of
the mechanism by which it was to be achieved.
In parallel with its primary argument that Article 81(1) did not apply, GlaxoWellcome
put forward reasons why an exemption under Article 81(3) should be granted. By way
of reminder, Article 81(3) states
The provisions of paragraph (1) may, however, be declared inapplicable in the
case of [any agreement or concerted practice] which contributes to improving
the production or distribution of goods or to promoting technical or economic
progress, while allowing consumers a fair share of the resulting benefit and
which does not:
estion.
(a) impose on the undertakings concerned restrictions which are not
indispensable to the attainment of these objectives;
(b) afford such undertakings the possibility of eliminating competition in
respect of a substantial part of the products in qu
In other words, four conditions have to be satisfied:
• the anti-competitive effects of an agreement must be outweighed by the benefits in
the form of promotion of technical or economic progress or contribution to
improving the production or distribution of goods
• these benefits must be shared with consumers
• the restrictions imposed must be no more than are indispensable, and
• competition must not be eliminated.
Economic progress argument
The benefit of promotion of technical progress on which Glaxo relied was the simple
equation that greater profits would enable it to carry out more research and thereby
improve healthcare. The Commission was not persuaded. It said no convincing evidence
had been presented that the R&D budget had been affected at all by parallel trade. Even

if there were any causal link between the two, parallel imports accounted for only 2% of
total pharmaceutical sales in the EU in 1995, and even in the UK, which has some of the
most parallel-import-friendly policies, they were only between 4% and 8% of sales. Out
of these, a proportion is attributable to currency fluctuations (sterling having risen
steadily against the Spanish peseta over the period) rather than the pricing system. The
Commission did not attempt to quantify what proportion of the total was attributable to
the regulatory pricing regime, but considered that at such low levels any shortfall in
profits available for research could be made up by adjusting the company’s budget in
other areas, such as marketing. In short, the R&D budget is entirely at the company’s
discretion, and GlaxoWellcome had admitted that it was influenced by a number of
factors. Further, as a percentage of turnover, the R&D budget grew in the relevant
period from 13.9% to 14.4%. The fact that in absolute terms turnover declined was due
to patent expiries, not parallel trade, and there was no guarantee that increased profits
from a reduction in parallel trade would go into that budget. Glaxo was unable to point
to any particular projects for which funding had been cut as a result of the impact of
parallel trade, although it tried – it could not deny that all pharmaceutical development
projects are highly speculative until the moment all clinical trials have been successfully
concluded and the marketing authorisation is about to be issued. There is no way to link
funding fluctuations with the success or failure, continuance or discontinuance, of any
particular project.
The justification that increased profits mean improved research and products is weak in
any case since:
• there is no external, objective target spend on R&D for any pharmaceutical
company to achieve, and
• it is acknowledged that blockbuster drug discovery is, despite recent developments
of high-throughput screening and towards rational drug design, very much a hit-
and-miss affair. An extra £1m spend does not guarantee the discovery of a further
breakthrough product. Conversely, the impact of the deduction of £1m from that
budget on the probability of discovering a new and useful product or improvement,
is literally incalculable: the uncertainty is too great.
In effect, the Commission has said that, having concluded that the impact of parallel
imports on GlaxoWellcome’s profits is apparently minimal, it is prepared to live with
the risk that some potentially useful research may be delayed or even left undone as a
result of that impact.
On the second option, GlaxoWellcome suggested that rational distribution within Spain
is hampered by parallel trade – wholesalers are too busy making profits from exports to
provide the level of service they are being paid for, and shortages may result from too
great a proportion flowing overseas. It hinted also that product launches might be
delayed in Spain under the current regime because of the risk to profits elsewhere of
having competing products parallel imported from Spain. Again, the Commission
concluded that there was no real evidence of any actual shortages or any decision not to
introduce a product in Spain as a result of parallel trade or at all. The Commission
commented that, even at a low price, the products were put on sale because they still
make some positive contribution to Glaxo’s profits. Although there were delays in
product launches in some cases, there were equally delays in product launches in other,

high-priced countries, including the UK. It might be that negotiating the reimbursement
price took longer in some cases than others, or any number of other factors. For the
moment, Spanish consumers seem to be getting the drugs they need.
Benefit to the consumer argument
Glaxo needed to demonstrate that the benefits it was claiming for the pricing scheme
would be shared with consumers. This is always difficult given that the application of
Article 81(3) to an agreement is premised on that agreement being anti-competitive,
which ultimately implies higher prices or other equivalent disadvantages to consumers.
The position is also complicated in respect of schemes aimed at reducing parallel
imports by the fact that the consumers in question are spread over several countries, and
is further complicated in pharmaceutical cases by the position of national governments
as the main purchaser of drugs in any country.
The intrinsic difficulty of demonstrating consumer benefit is reflected in Glaxo’s
negative arguments. It stated that Spanish consumers would not be harmed by the
scheme since domestic sales would be unaffected, nor would UK consumers notice any
change since in the UK consumers pay a flat charge for prescription drugs, with the
government picking up the balance of the price paid by the pharmacist to the supplier.
The UK government would not be harmed as a consumer either, since the amount it
spends is based on fixed reimbursement prices (negotiated in the UK) less a 4–5%
‘claw-back’ to obtain for itself a share of the benefits that pharmacists can obtain by
buying cheaper parallel imports.
Of course, these points would apply equally in respect of a hypothetical ‘reverse parallel
import’ that increased the price at wholesale level. This adds up to an argument that
consumers in both countries, individual and government, are in fact price insensitive
within the range of price levels under discussion. Where, then, are the benefits being
shared with consumers?
Glaxo fell back on the increased R&D spend and the long-term improvement in
healthcare as a result of new products being developed.
The Commission’s analysis was blunt – it can be summed up as ‘we’ve heard all this
before …’ They pointed out that consumers who pay full price or a price calculated by
reference to the actual cost to the pharmacist do benefit – and in several European
countries, consumers do pay a price on that basis. The argument has to be conducted in
terms of the EU-wide picture; it is not appropriate just to compare the UK with Spain.
Finally, governments, pharmacists and insurers are consumers too and they would
certainly benefit.
Indispensable restrictions argument
Glaxo claimed that the restrictions imposed by the agreement were indispensable since
there was no other way to eliminate the distortion of competition that the Spanish
authorities were causing. The Commission, on the contrary, found no evidence that
these restrictions would achieve the stated objectives, let alone that they are
indispensable.

Competition eliminated argument
On the fourth point, Glaxo argued that competition would not be eliminated by the
introduction of the scheme since it does not operate any exclusive distribution scheme
in Spain. In any case, since under the UK scheme the reimbursement prices and the
amount of the claw-back are not tied to the amount the pharmacist actually pays, the
only beneficiaries of the actual difference in price between the real-world supply and
fixed reimbursement level are the pharmacist and the parallel importer. In effect, what
good is competition anyway in such a system?
On this point, the Commission concluded that it did not need to answer since the four
conditions are cumulative and it had already decided that the first three had not been
met. The retort that competition across Europe is distorted is not really relevant since
this question is about eliminating it. There is a grumble which recurs several times in
the decision, namely that Glaxo seems to be trying to put the burden on the Commission
to show that its intervention will help or harm consumers. Not at all: the whole point is
for the applicant to demonstrate the benefits of its scheme.
Prospects for an appeal
The role of the Court of First Instance of the ECJ, to which the appeal lies, is not to
examine the merits of the Commission’s decision but to consider whether the
Commission has violated the Treaty of Rome. It may revisit the inferences drawn from
the primary facts but will not generally investigate the facts found by the Commission.
The prospects of a successful appeal against this decision are not good. The finding that
GlaxoWellcome’s scheme was either a dual-pricing scheme or had the same effect as
one meant that the subsequent discussion of issues, such as the impact on distribution or
benefit to consumers, was secondary. Under the Court’s established case law, the
agreement was bound to be prohibited and was unlikely to be eligible for exemption.
The additional findings of fact on the grounds for a possible exemption are also very
unhelpful: the lack of demonstrable benefit to progress or distribution, in particular, will
be extremely difficult to overcome.
Future dual-pricing strategies
This decision demonstrates once again that the European competition authorities have
little sympathy for the pharmaceutical companies’ resistance to parallel trade in their
products. Express dual pricing as a mechanism for dividing up the European market is
unlikely ever to be permitted. Mechanisms that achieve a differential pricing in practice
will need to be justified by thoroughly documented evidence of their substantial direct
positive impact on research spending, and of actual problems that parallel trade is
causing to the proper functioning of the distribution system. Without evidence of this,
any future dual-pricing strategy is likely to be found anti-competitive and thereby
prohibited.
About the author
Lorna Brazell is a partner in the intellectual property department at Bird & Bird, whose
work focuses on advising clients on suitable and effective strategies for the protection of
their intellectual property. She studied competition law at King’s College London as part

of her LLM degree in 1993 and advises on the impact of competition issues in all forms
of intellectual property agreement. With a technical background in the physical sciences,
she has also worked on the enforcement of rights through litigation across a range of
industries, including chemicals, electronics and biotechnology. Her reported cases
include Oxford Gene Technology Ltd v. Affymetrix Inc.

CHAPTER 15
Additional information about pharmaceutical pricing and
reimbursement
Regional differences in pharmaceutical prices
World
In 2001 the Australian Productivity Commission produced a study comparing
pharmaceutical prices of 150 top-selling drugs (by molecule) in Australia, under the
Pharmaceutical Benefits Scheme, with those in seven countries. A basket of products at
manufacturer price, using IMS Health data, was converted to a common currency and
weighted to ensure that a fair comparison was made. Table 15.1 shows the gulf in
prices.
Table15.1 Price ratios for all pharmaceutical categories (list prices)a
Unit Aust US Can UK Swed Fra Spain NZ
Higher
estimate
Ratio 1.00 3.48 1.81 1.64 1.57 1.17 1.02 0.98
Lower
estimate
Ratio 1.00 2.62 1.51 1.48 1.48 1.12 0.96 0.92
a
As the bilateral comparisons are based on Australian consumption patterns and different bundles
of pharmaceuticals for each country comparison with Australia, conclusions about relative price
levels across countries cannot be drawn. A higher and lower estimate is used, as pack sizes and
multiple manufacturer prices create difficulties in comparisons.
Source: PC Estimates/Australian Productivity Commission
A very large price gap was observed for the US, where list prices are about 250% higher
than those in Australia.
The study also compared prices by therapeutic group using the ATC code. Again, the
top-selling 150 items in Australia were used (see Table 15.2).
Table 15.2 Price ratios for ATC groups (list prices)a
ATC group US Can UK Swed Fra Spain NZ
Alimentary tract &
metabolism
Anti-neoplastic &
immunomodulating agents
3.7 1.6 1.7 1.9 1.3 1.1 0.7
Blood & blood-forming
organs
1.8 1.4 1.1 1.2 1.2 1.0 1.4
Cardiovascular system 2.5 1.6 1.5 1.3 1.2 1.0 0.9
Dermatologicals 4.0 1.5 1.0 1.0 0.9 0.7 0.7

Table 15.2 (continued)
ATC group US Can UK Swed Fra Spain NZ
General anti-infectives for
systemic use
2.0 0.9 1.4 1.3 1.0 0.8 0.9
Genito-urinary system and
sex organs
4.2 1.3 1.5 1.4 0.9 1.0 1.4
Musculo-skeletal system 2.1 1.6 1.6 1.9 1.0 0.8 0.8
Nervous system 2.3 1.3 1.4 1.4 1.0 1.1 1.2
Respiratory system 4.1 2.0 1.7 2.8 1.4 1.1 1.2
Sensory organs 1.8 1.1 1.2 1.1 0.8 0.7 0.9
Systemic hormonal
preparations, excluding sex
hormones
2.4 0.5 1.0 1.0 0.8 0.5 0.7
Various 1.4 1.4 2.2 nm 1.2 0.4 1.3
a
As the bilateral comparisons are based on Australian consumption patterns and different bundles
of pharmaceuticals for each country comparison with Australia, conclusions about relative price
levels across countries cannot be drawn. Figures in this table are based on lower estimates of
prices. The price ratios reported with a value greater (lower) than 1 indicates that manufacturer
prices for the matched forms in the comparison country are greater (lower) than the prices of those
in Australia. nm = no matches were identified in this category.
Table 15.3 Summary of pharmaceutical cost-containment methods
used in 18 European countries
Austria
Belgium
CzechRepublic
Denmark
Finland
France
Germany
Greece
Hungary
Ireland
Italy
TheNetherlands
Norway
Portugal
Spain
Sweden
Switzerland
UK
Ctrl ex-man. price × × × × × × × × × ×
Ctrl reimburs. entry × ×
Cross-country comp. × × × ×
Reference pricing × × × × × × × × × ×
Payback/contracts × × × × × × × × ×
Profit ctrl × × × × × × × × × × × × × × × ×
Promotional spend ctrl × × × × × × × × × × × × × ×
Prescribing budgets × × × × × × × × × × × × × ×
Pharmacoecon. evid. × × × × × × × × × × ×
Fixed wholesale margin × × × × ×
Fixed pharmacy margin
Generic substitution × × × × × × × × × ×
Patient co-payment × ×
Ctrl of OTC price × × × × × × × × × × × × × ×
Ctrl of hospital price × – × × × × × × × × × × ×
Key: = yes; × = no
Source: Urch Publishing/EFPIA

ADDITIONAL INFORMATION
Figure 15.1 Estimated costs paid by the patient in the total reimbursed
pharmacy market value at retail prices, 2000 (%)
8 5.9
8 0.3
5 4.2
6 1.7
9 5.1 9 1.5
8 2.0
8 9.9 9 0.7 9 2.9
8 6.9
6 8.3
9 2.0
7 3.8
9 0.9 9 4.0
8 3.1
1 4.1
1 9.7
4 5.8
3 8.3
4.9 8.5
1 8.0
1 0.1 9.3 7.1
1 3.1
3 1.7
8.0
2 6.2
9.1 6.0
1 6.9
0
10
20
30
40
50
60
70
80
90
100
A
ustria
Belgium
Denm
ark
Finland
FranceG
erm
any
G
reece
Ireland
Italy
Netherlands
Norw
ay
Portu
gal
Sp
ainS
w
eden
Sw
itzerland
UK
A
verage
%
Costs paid by compulsory health insurance systems (%) Costs paid by the patient (%)
Note: For France, co-payment data do not include costs paid by supplementary insurance (mutual
or private).
Source: EFPIA (member associations)
In all EU countries the reimbursement system operates a co-payment system requiring
patients to meet part of the cost of their prescribed treatment.
Figure 15.2 Average time intervals between application and award of
pricing and reimbursement (days)
67
1 24
2 15
3 61
66
2 64
1 02
56
4 52
2 78
4 64
0 100 200 300 400 500 600
Sweden
Spain
Italy
France
Portugal
Greece
Belgium
Average num berof days
P ric ing R e imbu rs eme nt
Source: Europe Economics (2000)

US
The annual study by the Kaiser Family Foundation provides some interesting data on
the prices and consumption of drugs in the US.
Figure 15.3 Average retail prescription prices, 1990–2000
22.06
23.87
26.33 26.99
28.67 30.00
32.86
35.72
38.43
42.42
45.79
$0
$5
$10
$15
$20
$25
$30
$35
$40
$45
$50
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
$bn
Source: Kaiser Family Foundation/IMS Health, Inc., National Prescription Audit Plus, April
2001
Figure 15.4 Projected drug spending by and for the Medicare
population, 2001–11
$71
$81
$92
$104
$117
$131
$148
$165
$185
$205
$228
$0
$50
$100
$150
$200
$250
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
$bn
Source: Kaiser Family Foundation

ADDITIONAL INFORMATION
Figure 15.5 Manufacturers’ price increases for existing drugs versus
retail prescription price increases reflecting the use of
newer drugs, 1991–2000
7.20
5.50
3.00
1.70 1.90 1.60
2.50
3.20
4.20 3.90
8.2
10.3
2.5
5.1
5.8
9.5
8.7
7.6
10.4
7.9
0
2
4
6
8
10
12
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Percentage change from previous year
%
Man ufacture r Price Increase (inflation) Averag e Retail Prescription Price Increase
Source: Kaiser Family Foundation/Sonderegger Research Center
Manufacturers’ prices obtained from IMS Health can be considered the maximum
potential prices used by manufacturers. However, discounting is common, particularly
in the US where larger/institutional buyers negotiate substantial price reductions. The
Australian Productivity Commission’s study into pharmaceutical prices estimates the
discount rates in the US by using Federal Supply Schedule prices (FSS) – a catalogue of
manufacturers’ prices containing over 17,000 pharmaceutical products.
Figure 15.6 Generic drugs as a percentage of total prescriptions
dispensed and percentage of total annual retail
prescription sales, in US dollars, 1996–2000
42.5 42 42 43.2 42.3
20.5 19.9 19 18.5 17.8
0
5
10
15
20
25
30
35
40
45
50
1996 1997 1998 1999 2000
%
Perc entage of total presc riptions dispensed
Percentage of total annual retail pres cription sales
Source: Kaiser Family Foundation/Sonderegger Research Center

Table 15.4 Estimated discounts for larger/institutional buyers in the
US
Higher estimate Lower estimate
Category Price ratio Discount (%) Price ratio Discount (%)
All 2.49 24 1.84 31
New innovative 1.94 6 1.86 3
Me-too 1.94 34 1.7 39
Generics 4.00 14 2.08 24
FSS prices are likely to provide a conservative estimate of the discounts available in the
US, as other prices with health management organisations (HMOs) tend to be
confidential.

PRICING TERMINOLOGY
Pricing terminology
Blacklist
A list of prescription drugs that are
specifically not eligible for reimbursement or
can only be prescribed for certain patients
which specific conditions. The UK has had a
blacklist for around 15 years. Most famously,
Viagra (sildenafil) was blacklisted so that only
men with certain conditions (other than
erectile dysfunction) such as diabetes could be
prescribed it on the NHS.
Bundling
Most manufacturers will respond to a bid with
a long list of additional products and services
that are ‘bundled’ as part of the base price,
making comparisons with other products
impossible. Some manufacturers offer
additional ‘free’ services when the customer
commits to a certain purchase volume.
Co-payment (see also reimbursement rate)
The fee that a patient pays for a product
(usually on prescription). Usually this is a flat
fee or a percentage of the reimbursement
price.
Cost containment
Related to pharmaceuticals, cost containment
usually applies to the overall attempts by
government and healthcare payers to limit the
total spend on pharmaceuticals to within pre-
defined budgets or percentage of total health
spend.
Delisting
Removal of products from the reimbursement
list. There are three forms of delisting:
disallowing reimbursement for products;
disallowing OTC products that otherwise
could be prescribed and reimbursed; and
forced switching of prescription drugs to OTC
status. Generally, delisting is used to shift
medical costs to consumers by requiring them
to pay for products that treat minor illnesses or
elective therapies (e.g. vitamins, oral
contraceptives).
Demand-side controls (see also supply-side
controls)
There are many ways in which the price or
consumption of pharmaceuticals can be
limited. Controls that are commonly used
include prescribing budgets for doctors or
incentives to prescribe cheaper products,
prescribing limitations, i.e. the number of
products per prescription and patient co-
payments (see separate entry). Demand-side
controls are generally seen to cause less
market distortion than supply-side controls.
Direct price control
Direct control of prices is the ultimate
government restriction. In countries that do
control prices directly, the price of a new drug
will be determined prior to its launch, via
negotiation between the government and the
company concerned. Prices may also continue
to be controlled after launch. The degree to
which this happens varies between countries.
In Japan, every 2 years the Ministry of Health
and Welfare conducted a survey of the prices
being charged for pharmaceuticals and reset
the ‘official’ (National Health Insurance
reimbursement) price for individual products
accordingly.
Extinction pricing
Extinction prices are set low to eliminate the
competition. Usually this will be below what
the company can justify on the basis of its
production cost. The objective is to harm the
competition financially, even if it entails a loss
to the producer. Once the competition is
eliminated, prices can be raised to profitable
levels.
To be able to pursue such a strategy, a
company must be dominant within the market
and have a solid financial base in order to
absorb the resultant financial losses.
Extinction pricing has come under attack as it
can be considered to be a form of illegal price
discrimination which may severely lessen
competition or create a monopoly. No
company would publicly acknowledge such a
pricing policy. Frequently, selective price cuts
on items within a product line are used as a
mild form of extinction pricing.
Fourth hurdle
The use of formal assessment of the cost and
clinical effectiveness of new medicines is now
becoming a common feature of healthcare
decision worldwide. Health technology

assessments (HTAs) are being used
increasingly by some payers to undertake
reviews that form the basis for decisions on
pricing, reimbursement and access to
treatment (e.g. NICE in the UK). These
developments come as a consequence of
government budgetary pressures. The issues
raised by such activities are of growing
concern to the pharmaceutical industry, which
has had to react by providing economic and
quality-of-life evidence for what has been
dubbed the ‘fourth hurdle’ in the regulation of
new medicines. More accurately, it is a post-
licensing hurdle to gaining access to particular
customers.
Free pricing
The company is allowed to price its products
with no interference from payers or regulators.
In reality, true free pricing of pharmaceuticals
rarely exists.
Government
Government restrictions are the single most
important factor in the pricing equation. The
pharmaceutical industry is remarkable for the
high level of government regulation. This
regulation extends to the safety and efficacy of
new drugs, their distribution, where they may
be sold and their price.
In most of the major pharmaceutical markets,
the government, via the medium of some form
of national health service, is the principal
buyer of pharmaceuticals within its national
boundaries. Even where this is not the case,
such as in Japan, the government still has a
strong regulatory hold over the prices of
pharmaceuticals. The main current exception
to the rule of strong government control is the
US.
There is an overt responsibility for
governments to regulate and monitor safety
and efficacy trials in the approval process,
whereas there is no such responsibility to
ensure that the newest and most innovative
treatment for a particular condition is available
to all those who require it.
G10 Medicines Group
(High-level Group Innovation and the
Provision of Medicines)
This brings together a select group of 10 top-
level decision makers from the EU. The Group
discusses the major issues relevant to the right
balance of health objectives and industry
competitiveness in Europe. Market structure
and price fall within its brief.
Health technology assessments
See fourth hurdle.
Indirect price control (see also direct price
control)
A range of measures are used by governments
to influence the price of pharmaceutical
products – usually to keep them below a
certain level. In many countries companies are
free to set any price, but the reimbursement
price is fixed by payer institutions or
government. In many countries reimbursement
is essential to the market success of a product
so companies will set an acceptable price.
Other indirect controls include pressure on
prescribers either through incentives or
penalties to use cheaper products such as
generics (see also demand-side controls and
supply-side controls).
International price linkage
(also known as international reference pricing)
Many countries use the prices of products in
neighbouring countries as a comparator. This
is particularly common in Europe where the
majority of countries use some kind of linkage
for introductory or reimbursement price
setting. For example, Denmark, The
Netherlands, Italy and Ireland all officially use
the prices within the UK as a benchmark for
their own. It is worth noting that some
countries unofficially use referencing. The
main objective of linkage is to ensure that
prices are either the lowest, average or no
higher than another country. The other
attractions are the opportunity to ‘free-ride’ on
other countries’ regulations and the flexibility
of choosing comparators. Critics of linkage
argue that it can delay product launches and
that there is little rationale for setting prices on
the basis of other countries’ health systems.
Launch sequence
The order of countries in which products are
launched. It clearly makes sense to launch a
product in the largest and most profitable
markets first and those where the price is
highest. Launch sequences are complicated
and to some extent dictated by international
reference pricing (linkage), particularly within

PRICING TERMINOLOGY
Europe, where the country in which the
product is initially launched is used as a
benchmark. So it broadly follows that the
high-priced countries are first followed by
low-priced countries, meaning that the overall
average European price is higher. For
example, within Europe, the UK and Germany
are high-priced countries so tend to be first in
the launch wave and Greece is the lowest
priced country so tends to be last. However,
sometimes companies will opt for a low price
in a first-wave launch country to achieve high
volume in second-wave markets. To ensure
that a launch sequence goes to plan, the time
lag between price application to the authorities
and the actual launch must be monitored, as
some countries are faster at processing
applications than others.
List prices and contract prices
Pharmaceutical and medical supplies’ pricing
varies widely between and within national
markets. Generally, higher prices are found for
pharmaceuticals in Northern European
countries as compared with Southern
European countries, but this is not always the
case. Most prices available to the public, such
as in the British National Formulary in the
UK, are ‘list prices’. No purchaser pays the
list price, although it can serve as an important
guide, as it is a published price observed by all
buyers. However, list prices can be unreliable
guides to pricing as most products are sold to
buyers at discount levels – anything between
5% and 96% of the list price. Therefore, for
true pricing comparisons to be made, it is the
discounted ‘contract price’ that needs to be
examined wherever possible.
Many European hospitals have found that
there can be considerable differences in
contract prices between themselves and other
hospitals, even in the same city. Many
European hospitals negotiate contract prices
for certain drugs as part of consortia, but will
privately admit to obtaining better contract
prices than their colleagues for other drugs
through independent negotiations with a
manufacturer. In one European buying co-
operative, contract prices for Bristol-Myers
Squibb’s Taxol varied up to 50%. Despite
what pharmacists and hospital managers say,
there is very little exchange of pricing
information and market intelligence between
hospitals. This puts the pharmaceutical
industry in a very strong position to control
prices.
NICE (National Institute for Clinical
Excellence, UK)
NICE was set up 1999 as part of the National
Health Service (NHS). Its role is to provide
patients, health professionals and the public
with guidance on current best practice of both
individual health technologies (including
medicines, medical devices, diagnostic
techniques and procedures) and the clinical
management of specific conditions. Although
NICE has no influence on the price of
products, it can recommend whether a product
should be widely prescribed. Other countries
that have similar institutes include Australia
and Sweden.
Negative lists
A list usually controlled by government
comprising names of pharmaceutical products
that will not be reimbursed. This type of pricing
control has been introduced in a number of
European countries since the early 1980s and
has been periodically extended in those
countries.
Net realised price
The price after the deduction of discounts, free
samples, etc.
Optimal price
Companies strive to set a price that will
deliver the most global profit – the optimal
price. The structural relationship between
price and profit is not straightforward, as
many variables influence the price of
pharmaceuticals, including: competition, price
controls, efficacy, delivery system, volume
effects, size of market, products and
distribution costs.
Parallel importation (also ‘grey market’)
Parallel imports of pharmaceuticals, which are
sometimes referred to as ‘grey market’
imports, are cross-border trade in a given
product, without the permission of the
manufacturer. Parallel importation of
pharmaceuticals exists where there is a
significant price difference for the same
product in different markets.
Generally, under international law, parallel
imports are considered legal owing to

agreements on intellectual property. The
technical issue is the so-called ‘exhaustion’ of
an intellectual property right, which is
sometimes referred to as the ‘first sale
doctrine’. Under the theory of the ‘first sale’
or the ‘exhaustion of rights’, the owner of
intellectual property cannot control the resale
of a legally purchased good, and parallel
imports are legal. Under World Trade
Organisation (WTO) rules, countries are
permitted to decide for themselves how to
handle parallel imports. Restrictions for
parallel imports, in general, exist only for
certain types of goods. In the US, parallel
trade is not permitted for some copyrighted
goods and regulatory authorities restrict
parallel imports of pharmaceuticals. However,
in Europe there is significant trade in
pharmaceutical parallel imports, particularly
within the EU, and also from outside the EU,
including imports from the US market to the
EU. A number of US distributors and
wholesalers now advertise on the Internet and
claim to supply specialised products to most
EU countries, notably the UK, Ireland and
Germany. In Japan, the Anti-monopoly Law
concerning distribution systems and business
practices specifically warns against restrictive
conduct with respect to parallel importing. In
July 1997 the Supreme Court of Japan rejected
arguments that parallel imports of patented
goods were contrary to international law.
In recent years, this trend has appeared in
Europe, and many patient groups are active in
lobbying for more support for their members.
As governments, medical agencies and other
official bodies have forged closer European
ties, so have European patient groups. Many
national patient groups are now part of larger
European bodies, and some of these, in turn,
are part of international patient groups.
Penetration pricing
A pre-emptive price strategy against possible
competition is to adopt a low price. As a
result, the prevailing price in the market is
unattractive to possible competitors. This
strategy is particularly well suited to products
for which the manufacturer does not hold a
patent or have a differential advantage over
other companies, and where market entry is
relatively easy. Delaying the entry of
competitors allows a company to gain market
share, reduce costs through scale and
experience efforts, and acquire brand
recognition as the original entrant.
Positive list
A list, usually prepared by the payer (i.e.
insurance company) comprising all products
that will be automatically reimbursed.
Products not listed may not be eligible for
reimbursement. Positive lists are in operation
in countries such as Belgium, Denmark,
France, Greece, Italy, Portugal and Spain. In
the US, there is no government-organised
positive list, but some of the very powerful
buyers of pharmaceuticals, such as the health
maintenance organisations (HMOs) operate
their own versions of positive lists via
formularies.
Patient groups
Since the late 1980s there has been a major
change in the way patients are perceived by
the pharmaceutical industry and clinicians.
Patient advocacy groups now wield
considerable influence in determining how
successful a given therapy will be and cannot
be looked upon as passive bystanders willing
to accept what a drug company or clinician
tells them. Patient groups are particularly
active in North America, having considerable
financial assets to lobby for their rights at
national and international governmental level.
Many national patient organisations have
gained the support of celebrities and are
subject to substantial media coverage, and
disseminate information about themselves to
other patients via the Internet. Some of the
major areas in which ‘patient power’ has had a
significant effect on treatment include HIV
infection, disorders of the CNS, osteoporosis
and cancer.
Prestige pricing (quality pricing)
A prestige price is one intended to be
maintained throughout the life cycle of the
product in order to lend it prestige and quality
connotations. The high price itself serves as an
important motivation to buy the product,
which may be lost if the price is lowered.
Prestige pricing is reliant on price insensitivity
among consumers. The importance of quality
and prestige as buying motives is essential to
this. Ultimately, prestige pricing may be
replaced by the term ‘quality pricing’, which
has positive rather than negative overtones and
links customer satisfaction to the price

PRICING TERMINOLOGY
structure. ‘Quality pricing’ focuses consumers’
attention on how the product can satisfy their
expectations.
Price corridor
A band in which a product’s price falls – thus
there is a minimum and maximum price above
or below which the price will not fall. This may
exclude it from some markets, as it is too
expensive and may harm profitability in
another, but the overall reduction in differential
between the lowest and highest price should
contribute to global profitability. Some
companies use corridors to counter the effects
of parallel trade in their products. Operating a
global price corridor requires considerable
centralised control to see the bigger picture.
Price index (Europe)
The index is most often used in Europe to
illustrate the wide range of prices that the same
products have. Usually a selection of products
(often known as a basket) are grouped together,
the average price found and then compared
across countries. This is not dissimilar to the
Big Mac (McDonald’s) index that indicates the
cost of living in each country.
Price/volume agreements
Individual pricing/volume agreements have
been negotiated in a number of countries.
France has been especially active in this area.
Pricing/volume agreements limit the sales of a
product to a predetermined level that is
decided by negotiation. For example, in
France, the government seeks to limit the
volume of a drug sold to the expected
‘medically justified’ volume. In return for
volume limits, the manufacturer of a product
can receive a greater degree of pricing
freedom than would otherwise be expected.
Profit control
The overall profit of a pharmaceutical
company is usually controlled by capping the
profits that pharmaceutical companies make.
The most prominent example of a profit
control is the Pharmaceutical Price Regulation
Scheme in the UK, which has been in
operation since 1957 and is renegotiated
periodically. The objective of this scheme has
been to hold down NHS pharmaceutical
spending whilst maintaining an efficient and
dynamic pharmaceutical industry in the UK. It
limits the amount of profit that each individual
company can make in a year from selling to
the NHS. The upper limit for pharmaceutical
profits for an individual company is set by
negotiations between the company and the
government.
Profit maximisation
Economic theory assumes that the singular
goal of business is to maximise profit.
Although this may actually remain the goal of
most companies, its negative connotations for
the public mean that it is rarely acknowledged.
For example, Viagra was believed by industry
analysts to represent a gross profit margin of
98%, although Pfizer has refused to comment
on this.
Theoretically, if high prices prevail in
competitive industries, there will be greater
competition, and these additional suppliers
will keep prices at a reasonable level. In this
sense, profit maximisation is desirable, as it
results in a better allocation of resources.
Realistically, profit maximisation is a non-
operational objective, even though companies
may state such an objective as a primary goal.
The complexity of organisations and the
diversity of competition make it difficult to
assess exactly how profit maximisation can be
achieved. For example, it would be difficult
for most multi-product pharmaceutical
companies to understand exactly what effect a
change in output and sales would have on the
cost of any particular product in the line.
Reference pricing
Reference pricing has become popular with
governments, as it eliminates the
administrative burden of individual price
negotiations for each new product launched,
whilst containing expenditure on
pharmaceuticals.
Reference prices work by providing a fixed
level of reimbursement for a group of products
which compete with each other. In general, as
in the German system, the reference price level,
i.e. the fixed reimbursement level, is set higher
than the lowest price in the group, but not as
high as the highest price in the group. What
defines a group of competing products can vary.
In the German case, the first reference prices
were set for generic products with the same
active ingredient and the same indication,
which were therefore in direct competition.

After this move, the definition of a reference
pricing group was widened to include
chemically related substances that can substitute
therapeutically for each other. These could be
defined as ‘me-too’ products. In the third stage,
products that are chemically dissimilar but have
the same therapeutic effect can be included in a
competitive group.
The whole weight of the EU single market
effort is to create pricing transparency, and
this is backed up by national legislation
prohibiting price fixing through artificially
segregated markets. This is especially clear for
players with dominant market shares. The
Treaty of Rome states in Article 85 that
dominant players (with between 40% and 45%
market share) may not price discriminate in
national markets. National legislation puts
tighter limits on this, with the UK defining
dominance at 30% market share and Denmark
stipulating 25% market share. Furthermore, no
official secrets act aims to create
disadvantageous contract conditions for public
institutions by prohibiting public employees
from discussing prices with other buyers on
the market.
Reimbursement rate (see also co-payment)
In most Western countries the cost of patients’
drugs are reimbursed by the health insurer or
NHS. The level of reimbursement usually
depends on the type or social circumstances of
the patient and severity of disease. Usually,
products for treating chronic and life-
threatening conditions such as diabetes and
cancer are fully reimbursed. Other conditions
may require the patient to pay a co-payment
either as a flat fee or a percentage of the total
cost. Co-payments are often capped at an
annual level. Children, pensioners, war
veterans, the disabled, etc. are often exempt
from co-payments. In-patient medicines are
often fully reimbursed. For example, in the
UK all out-patient drugs (on the positive list)
are reimbursed in full, bar a small flat fee co-
payment.
Skimming
A short-term measure that involves charging
the highest price possible for a product. It is
usually applied to a product that is innovative
or a desirable variation from what already
exists in the market and thus can achieve a
monopoly.
Skimming is short term, as sooner or later
competitors enter the market with similar or
near-identical products, thereby eliminating
the monopolistic advantage enjoyed by the
product. Skimming is most effective for
innovative, unusual or highly improved
products. Such products usually require high
R&D expenditure and promotional outlays to
raise their profile in their potential market.
High prices and margins are necessary to
cover such costs, as well as to recover the high
costs associated with the smaller production
runs at this initial stage.
Rx-to-OTC switching
The movement of pharmaceuticals from
prescription-only to OTC status, known as
switching, is a key stage in the product life
cycle of a number of major pharmaceuticals.
Switching a pharmaceutical can extend
product life cycle, and must be accompanied
by fresh pricing decisions relating to the new
environment that the product is entering.
Unlike prescription pharmaceuticals, OTC
products are not often price regulated, their
price is fully visible, and they are usually paid
for in full by the consumer. In addition to allowing the company to recover
its investment rapidly, skimming can also help to
build a higher quality image for the product
owing to its initial high price. As it is clearly
easier to lower prices than to raise them, initially
charging a high price allows the company the
luxury of lowering it when threatened by
competition. In contrast, a lower initial price is
difficult to raise without losing volume.
Secrecy
Many contract prices are not made public. A
common industry argument for this situation is
that this is strategic information that must not
fall into the hands of competitors. Some
buyers will quote public secrecy acts as a
reason why public-sector employees cannot
disclose price information, even within their
own ranks. The legality of these secrecy acts
has been called into question by hospital
buyers interested in knowing whether they
have obtained the best prices from a supplier.
Supply-side controls (see also demand-side
controls)
A product’s price or consumption can be
influenced by supply-side controls – these

PRICING TERMINOLOGY
include controls on price, set margins for
wholesalers and pharmacists, and the
imposition of VAT. The control of margins is
particularly important, as wholesalers and
retailers could be financially incentivised to
provide/dispense cheaper products by taking a
proportionally larger margin than a more
expensive equivalent.
Target return on investment
Target-return pricing focuses on determining
the necessary mark-up per unit sold to attain
the overall target profit goal. The margin
estimation must be considered to be just,
reasonable or customary before being added
to each product’s cost. In this way, both cost
and profit goals are based on standard
volume. The definition of investment in this
case is net worth plus long-term corporate
debt.
Whilst it remains a frequently used strategy,
target-return pricing is effective only as an
overall performance measure of the entire
product line, rather than of individual
products within the line. For individual items
in the line, certain strategic pricing
considerations may require raising or
lowering the price, leading to setting either
higher or lower target rates in each case. For
example, a high price may be considered for
a drug offering a major therapeutic advance
to lend prestige or a quality image to the
entire range of products in a manufacturer’s
line. A low price on another item may be
used to generate sales.
When applying target-return strategies, the
allocation of return on investment among the
various products within a line is problematic.
It is extremely difficult to value capital assets
correctly as it may be unclear whether this
should be done according to the book value
or the present value of assets in calculating
the desired ratio. An additional problem lies
in deciding what percentage of the target
return should be derived from the various
items in the line. Products vary in terms of
their capital investment, market share,
established image, stage of life cycle and
competitive pressures. It would be a strategic
mistake to expect to receive the same rate of
return on investment from each product in
the line, or to achieve this rate of return
equally every year.
Tendering
Purchasing patterns vary widely across Europe
and often conflict with EU tendering rules. The
EU tendering rules apply to all public purchases
above €200,000, but many purchasers do not
use tenders, or employ them only on a limited
basis. They therefore miss out on benefits and
can run the risk of legal action from dissatisfied
manufacturers.
UK hospitals are well advanced in the
tendering process, using EU public tendering
on a routine basis. At the other end of the
scale, more recent entrants into the EU, such
as Sweden, appear less ready to use tenders. In
The Netherlands, EU tendering is used only by
larger hospitals when conducting joint
purchases.
The experience level of the purchaser can
determine the type of tender selected. Less
experienced buyers prefer a limited tender
going out to a pre-defined group of suppliers.
However, this excludes potentially interested
new competitors from participating and runs
the risk of their taking legal action. More
experienced buyers, such as AMGROS in
Denmark, find that by using the public tender
the number of bids is manageable and the
response better. They find the tendering
process less time consuming than the limited
tender and, from a legal point of view, less
complicated.
Volume controls
When governments limit the number of
pharmaceutical products which may be
reimbursed, either by inclusive or exclusive
lists, the volume of pharmaceuticals used may
be reduced.
References
Urch Publishing (2001) The Guide to European Pharmaceutical Pricing and
Reimbursement Systems. London: Urch Publishing.

Productivity Commission (2001) International Pharmaceutical Price Differences
Research Report. Canberra: AusInfo.
Kaiser Family Foundation (November 2001) Prescription Drug Trends: a chartbook
update. Available at http://kff.org

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