Researchers map systematic overcharging of generic drugs

Price cycles in the market for prescription drugs after the expiry of patents.

In Denmark, generic prescription drug prices are determined through bidding rounds, which the Danish Medicines Agency holds every other Monday.

The bidding rounds are supposed to ensure low prices for prescription drugs whose patent has expired, as pharmaceutical companies offering generic drug products can compete on price via the bidding.

Generally speaking, the product with the lowest price is the one that Danish pharmacies are supposed to dispense to patients over the subsequent two weeks until the next round of bidding. The scheme more or less guarantees the company offering the lowest price approx 70 per cent of the market for 14 days.

However, in 2016, two researchers from the University of Copenhagen’s Department of Economics, postdoc Anders Munk-Nielsen and PhD student Frederik Plum Hauschultz, started analysing the prices of prescription drugs. Surprisingly, they discovered a number of significant price increases that were much greater than what would normally be expected in a healthy competitive market, thus prompting them to start looking more closely at price trends in the generic drug market.

Method

The research involved checking data covering purchases of prescription drugs over an entire 17-year period from 1998 to 2015.

This data included prices and quantities for prescription drugs and more than 2,000 different substitution groups, which are the medication packages that consumers may choose between at a pharmacy with a given prescription - i.e. medication containing the same active ingredients and the same dosage.

Results

By going through such large amounts of data, the researchers were able to identify over 3,000 cases since 1998 where the market price of a drug rose by over 50 per cent during the two-week price period from one bidding round to the next.

Price increases were often well over 100 per cent and were, as a rule, followed by a very slow fall in price, taking a year or more be-fore the price returned to its original level.

These sharp and sudden price hikes did not come about as a result of increased demand, which researchers can demonstrate with the detailed data on prescriptions and drug purchases in Denmark. Nor is it a result of increased production costs: A comparative study on the same products showed that prices in Sweden are not subject to the same sudden price hikes, even though they usually follow the same patterns as Danish prices. This suggests that far from being the result of market trends, these price fluctuations are a sign that competition in the Danish prescription drug market has been weakened.

The picture doesn’t look good when you consider that there are some 3,000 examples of prices increasing from one pricing period to the next by more than 50 per cent. What it tells us is that there are certain challenges to be overcome if we are to improve the competitiveness of the market. The scope of the problem has taken us by surprise. There are so many red warning lights flashing in the research analysis that it seems to us an area that politicians should be urgently taking a closer look at.

The two researchers also found that the number of pharmaceutical companies participating in bidding rounds is typically lower than usual in a period leading up to a price hike, which only serves to weaken competition further as prices normally fall back to their original level faster in markets where there are several companies competing.

As a result of Munk-Nielsen and Hauschultz’s analysis, the Danish Competition and Consumer Authority can, for the first time, get a clear picture of exactly what happens to prescription drug prices when a company wins a bidding round; at the same time, politicians now have the opportunity to change the system so that it will be more difficult for pharmaceutical companies to suddenly inflate their prices at will.

Anders Munk-Nielsen and Frederik Plum Hauschultz point out that the main problem in the Danish bidding system is that the pharmaceutical company who wins a bidding round for a particular type of drug typically only gains approx. 70 per cent of the market over the following 14-day period.

This is partly due to the fact that the pharmaceutical company who wins the round often sells out of its product during the two-week pricing period, after which the next cheapest product will take over the market. Another reason is that some consumers prefer to stick to a certain brand of drug they know well, rather than buying an identical drug with a different name and with different packaging, thereby ignoring the chemist’s suggestion to buy a cheaper brand.

As the winning pharmaceutical company only gets some 70 per cent of the market, the other companies covering the remaining 30 per cent of the market can still earn well in that particular pricing period, again by charging very high prices. If the winning company got the entire market, the other companies would be forced to compete by offering lower prices.

On top of this, the low 70 per cent market share which goes to the winner means that all the other pharmaceutical companies also get a share of the artificially high prices which occur for the relatively long period that prices gradually go down again after a price hike. If a company was given the entire market, the other companies would have to compete harder.

Munk-Nielsen and Hauschultz have therefore identified a number of specific changes that can ensure better competition between the pharmaceutical companies in the Danish Medicines Agency's system of bidding rounds, thereby leading to lower medical costs for society in general:

• Tougher pricing regulations:
  Under the current system, a pharmacy only has to suggest a cheaper drug if the product stated on the prescription is more than five per cent more expensive than the cheapest. This weakens competition unnecessarily.

• Sort medical products by price:
  At the moment, products are sorted alpha-betically in doctors' IT systems, which means that products whose name starts with letters near the beginning of the alphabet are used far more for prescriptions and thereby enjoy higher sales. Instead, it would make more sense to sort products according to price so that the cheapest products appeared at the top of the list.
  

• Conceal prices from previous bidding rounds:
  At the moment, it is very easy for pharmaceutical companies to find information on what the prices of similar products were in previous bidding rounds, so they can get a good idea of the price level and set their bid accordingly. In most similar auction-type systems with public tenders, the contracting authority ensures that the competing parties’ bids are kept secret in order to avoid exactly this current situation where companies can coordinate their bids.

• Delivery shortages should be minimized:
  There are a large number of supply shortages, which arise when companies win the bidding round, but then report that they are not able to deliver the drug required. At the moment, this does not result in any sanctions against these companies. Authorities should therefore investigate why these delivery shortages occur and whether imposing a fine will be an effective means to minimize the number of failed deliveries.

We’re talking about very substantial price increases here, indicating that pharmaceutical companies competing in the Danish market are raising their prices irrespective of costs, thereby significantly boosting profits. This can adversely affect the very fragile health service budgets which provide subsidies for the drugs, as well as negatively impacting on patients, who often end up paying far too much for the drugs they need.

Further research

Anders Munk-Nielsen and Frederik Plum Hauschultz are now working on more closely examining the phenomenon of price cycles, which has previously only been observed in the petrol market.

The first thing they aim to do is identify how price cycles affect demand.

Their hypothesis is that demand in a given market has a significant impact on whether price hikes occur or not.

About the report 'Price cycles in the market for prescription drugs after the expiry of patents'

• The report, published in November 2017, provided documentation of dramatic price increases in the market for prescription drugs across many different types of medication.
• The research results have led to calls for politicians to adjust practices in the market for medical drugs in order to prevent the situation whereby a pharmaceutical company which has just won one of the Danish Medicines Agency’s bidding rounds by offering the lowest prices subsequently raises their prices and thereby instantly increases their profits.
• The Danish Competition and Consumer Authority has requested that the Health Minister examine how the system of bidding rounds can be changed to prevent inappropriate price hikes.
• The research has been financed by the Economic Policy Research Network and the Independent Research Fund Denmark's Council for Society and Business.

Read the full report here (pdf format, in Danish)

Research period: 2016-2017

The Edgeworth-price cycle

• The price cycles investigated by Munk-Nielsen and Hauschultz are known as Edgeworth price cycles.
• This is a relatively rare but not unknown phenomenon which occurs in many countries, typically in petrol markets.
• It starts when prices are low, and one company decides to raise prices in the hope that the others will follow suit.
• When the price is high, the companies gradually undercut each other, taking turns to win market share and so share the profits from the price cycle between them.
• When the price is so low that profit margins are (almost) zero, one of the companies will again take the initiative and increase their prices while the others gradually follow suit again.
• The pattern of progressive price decreases then repeats itself.
• The Edgeworth cycle typically occurs in markets with only a few players and guarantees companies higher profits than healthy competition would normally allow.

Media reviews and publications

DR (Danish Broadcasting Corporation) Penge, 14 November 2017: You're paing over the odds for generic drugs.

Den offentlige (The Public Sector), 15 November 2017: Danes paying too much for their medicine