Parallel trade.qxp

Agenda
Advancing economics in business
Shades of grey: arguments for and
against parallel trade in pharmaceuticals
Last month the European Court of Justice announced its judgment on Syfait v GlaxoSmithKline,
the latest case concerning parallel trading (aka grey imports). One of the most pressing
competition issues facing the pharmaceutical industry, this topic was discussed during the
second Oxera Economics Council meeting that took place in Brussels on September 15th
Parallel trade in pharmaceuticals in the EU was worth Actions taken by pharmaceutical companies to limit approximately €4.3 billion in 2006.1 Parallel importers parallel trading are currently being investigated in a buy medicines under patent in Member States where number of competition cases, most prominently where wholesale prices are relatively low, and sell them at a pharmaceutical companies have refused to supply to higher price in other Member States—a form of parallel importers. September’s judgement of the international arbitrage. In other words, parallel traders European Court of Justice (ECJ) in the Syfait v find it profitable to re-package and export pharmaceutical GlaxoSmithKline case is one of the most recent products after they have been sold to a wholesaler by examples (see the box below). These cases raise the manufacturer. Because a guiding principle of the EU economic questions regarding the underlying rationale is the single internal market, parallel traders do not for implementing strategies designed to limit parallel require permission from the patent holders to export in this way. As parallel importing tends to reduce therevenues earned by branded pharmaceutical companies, This article focuses on three main questions which are there are incentives for these companies to attempt to important for understanding parallel importing, and where limit the amount of parallel trade occurring. This raises the important question––is parallel trade good or badfrom an economic point of view? – why does parallel trade exist in the EU? Syfait v GlaxoSmithKline AEVE, ECJ, 2008
Following a complaint by a wholesaler, Syfait, to the Greek
expressed his opinion that GSK’s conduct infringed
competition authority about GSK Greece’s refusal to
Article 82 because of the company’s failure to justify its
supply Greek wholesalers with three of its patented
actions economically. The argument that parallel trade has
products (Imigran, Lamictal and Serevent), the Greek
negative effects on R&D investments was in principle
competition authority initiated an investigation, and
accepted, but GSK’s conduct was considered to be
subsequently referred several questions to the ECJ.
disproportionate. The ruling of the ECJ on September 16th
Advocate General Jacobs advised the ECJ in 2004 that the
2008 found that a producer of pharmaceutical products
patent holder would not automatically infringe Article 82
must be in a position to protect its own interest if orders
(which prohibits abuse of dominance) by refusing to
from distributors are out of the ordinary. The court ruled
supply because the conduct might be justified in light of
that GSK’s actions would constitute an infringement of
sector-specific factors. The Advocate General’s advice
Article 82 when orders were at ‘ordinary’ levels, but left it
motivated the Greek competition authority’s decision in
to national courts to ascertain whether the orders in this
favour of GSK. At a more recent stage of the legal
particular case would be ordinary in relation to the
proceedings, in April 2008 Advocate General Colomer
requirements of the market.
Sources: Judgment of the Court of Justice in Case C-53/03 Synetairismos Farmakopoion Aitolias & Akarnanias (Syfait) and Others vGlaxoSmithKline plc and Others; Advocate General’s Opinion, Joined cases C-468/06, C-469/06, C-470/06, C-471/06, C-472/06, C-473/06, C-474/06, C-475/06, C-476/06, C-477/06, C-478/06, Advocate General: Ruiz-Jarabo Colomer, April 1st 2008; Advocate General’s Opinion inJoined Cases C-468/06 to C-478/06 Sot. Lélos Kai Sia EE (and Others) v GlaxoSmithKline AEVE, press release 19/08, April 1st 2008;Judgment of the Court (Grand Chamber) (2008), ‘Article 82 EC – Abuse of dominant position – Pharmaceutical products – Refusal to supplywholesalers engaging in parallel exports – Ordinary orders’, in Joined Cases C-468/06 to C-478/06, September 16th.
Oxera Agenda
October 2008
– why are prices different across Member States? compensate for the costs of unsuccessful drug – what are the potential welfare effects arising from developments. After patent expiry, ‘generic’ entry can occur and place a competitive constraint on pricing (thiscan raise competition issues in itself, although these are Why does parallel trade exist in
not the focus here since parallel trade more frequently Price-setting mechanisms in the pharmaceutical sector Once a drug is sold, the patent holder can no longer are different from those in many industries. New drugs restrict the circulation of the product within the EU. A brought to the market are afforded patent protection, buyer of a patent-protected drug is thus entitled to use which confers a temporary monopoly on its holder and dispose of it without further restrictions. In the (historically, this was often for 20 years, although this terminology of intellectual property law, patent rights are may differ across jurisdictions and products). Patent ‘exhausted’ within the EU territory. This principle is holders are thus not constrained by competition when consistent with the creation of a single European market.
setting prices during this period (they may still be Parallel trade within the EU would thus appear to be constrained by national regulations—see below). The rationale behind patent protection is that there aresufficient incentives to invest in pharmaceutical research, Wholesale prices for pharmaceutical products have that the costs of R&D and drug testing are recovered, traditionally differed within the EU. For example, and that returns from ‘successful’ drugs are sufficient to pharmacy purchase prices are on average higher in Third-degree price discrimination explaining parallel trade
Standard economic theory describes third-degree price
that consumers in market 1 would pay more and
discrimination as a situation where customers are charged
consumers in market 2 less. On balance, the welfare
different prices for the same product for reasons that are
implications of this type of price discrimination cannot be
unrelated to costs of production or the quantity sold. The
determined at the outset. There is clearly a redistribution
market is usually separated by time or location.
of income between buyers in the two markets (eg, is it
desirable that Greek consumers pay less for their
The stylised figure below shows two markets. In market 1,
medicines than German ones?). Price discrimination also
demand is relatively sensitive to price. Market 2 shows a
raises producer surplus at the expense of consumers.
market with inelastic demand. With price discrimination,
However, the overall welfare effect of this form of
monopolists would set prices equal to P1 in market 1 and
discrimination from an economic perspective usually
P2 in market 2. Prices are thus higher in markets with
depends on the following rule of thumb: if total output
inelastic demand, despite the marginal costs of production
under price discrimination is higher than under uniform
being the same. The shaded areas show the respective
pricing—ie, if it allows products to reach consumers that
producer surpluses (profits) in both markets.
would otherwise not be served—then price discrimination
Without price discrimination—or where such
raises welfare and parallel trade reduces it (eg, in the
discrimination is undermined by parallel trade—a
extreme, some national markets may not be served if
monopolist would charge the same price in both markets.
uniform pricing across all countries were required). This
The price level would thus be between P1 and P2, implying
is ultimately an empirical question.
Figure 1 Stylised illustration of third-degree price discrimination with monopoly pricing
inal cost 1
inal cost 2
Oxera Agenda
October 2008
Germany, the Netherlands and the UK than in Greece it cannot be ignored that such State intervention and Spain.3 The national pricing that creates [price regulation] is one of the factors liable to opportunities for parallel trade in the European market create opportunities for parallel trade.6 for pharmaceutical products therefore exhibits thecharacteristics of third-degree price discrimination, the Parallel imports thus create a tension between the economic welfare effects of which can be either positive principle of autonomy of Member States in setting or negative depending on the circumstances (see the pharmaceutical prices and the creation of a single European market. Price differentials in the EU are dueto the Member States each regulating their own Why are prices different in EU
pharmaceutical prices, while the principle of free Member States?
movement of goods within the EU allows traders toarbitrage those differences. An important question is why manufacturers are able tocharge higher prices in some Member States than in What are the potential welfare
others. Is it due to differences in price elasticity of effects arising from parallel trade?
demand or willingness to pay, as in the standard theoryof price discrimination? Or is it the result of other Price reductions for consumers
factors? In the case of pharmaceuticals, wholesale price Are wholesale price reductions resulting from parallel differentials for patented drugs mainly reflect differences trade passed on to end-consumers? Who are the main in the way countries regulate their pharmaceutical beneficiaries of those wholesale price reductions? markets and how prices are determined in negotiations Answers to these questions require a better understanding of the different distribution channels inthe pharmaceutical sector.
– Price controls. Member States apply different rules
for fixing wholesale pharmaceutical prices. For Parallel traders purchase pharmaceutical products from example, in 2003, unrestrained wholesale pricing of manufacturers in low-cost countries and sell them to patented drugs was permitted only in Germany and pharmacists in countries that offer higher margins.
the UK. Other countries imposed price caps in a Pharmacists sell those parallel imported drugs to variety of forms. In Portugal, for example, minimum end-consumers, who are then fully or partly reimbursed prices were set at the level of identical products in by health insurance. Health insurances are either publicly or privately financed, implying that the end-consumer and tax payer indirectly benefit from cost – Reimbursement systems. Insurers have incentives
to reduce overall expenditures on pharmaceuticalproducts by limiting reimbursed services. The design A study by the London School of Economics (LSE) of reimbursement systems differs across Member examines the effect of parallel trade in the Netherlands, States. For example, under the German reference Germany, the UK, Norway, Sweden and Denmark, the pricing system, the patient has to pay any amount in main destination countries for parallel trade in the EU.
excess of the maximum reimbursement price set by The study shows the extent of benefits arising due to the government.5 A co-payment mechanism requires parallel trade for parallel traders, pharmacies and health the patient to make some of the payments regardless – Parallel traders. As shown in Table 1 below, the extra
– Negotiations. National health and social insurance
profits made by parallel traders are considerably programmes are often ultimately controlled by the larger than the cost savings made by health insurance government. As a sole purchaser of pharmaceutical organisations and pharmacies.7 Parallel trade products, governments have a strong bargaining therefore causes a redistribution of profits from position to negotiate prices with patent holders.
manufacturers to intermediaries. A change in the Wholesale price differentials may therefore also reflect profitability of the different parties in the upstream country-specific policy objectives towards pricing of segment of the value chain could alter the incentives pharmaceuticals and profitability of pharmaceutical faced by the different parties. As a result, there may be a positive effect on investments in distributionsystems but a marginal reduction in R&D spending by The importance of regulatory restrictions on pricing increasing opportunities for parallel trade has also beenacknowledged in the recent judgment of the ECJ inrelation to the GSK Greece case: Oxera Agenda
October 2008
Benefits of parallel trade to parallel traders, pharmacies and health insurances, 2002
Notes: 1 Revenues and profits to parallel importers are calculated as the inter-price difference multiplied by the volume of parallel imports inthe destination country. 2 Benefits to pharmacies are estimated on the basis of the intra-country price spread between locally sourced andparallel imported drugs multiplied by the quantity of parallel imports sold. The effect on pharmacies excludes discount. 3 Savings to healthinsurance are calculated as the sum of direct cost savings due to the intra-country price spread and competition effects. Competition effects indestination countries describe the extent to which there is price competition and price convergence over time. 4 ‘Clawback’ refers to asituation where pharmacies have to share discounts received by suppliers with health insurances. Pharmacies are reimbursed at the list priceminus the clawback, which is usually expressed as a percentage of the price.
Source: London School of Economics (2004), ‘The Economic Impact of Pharmaceutical Parallel Trade in European Union Member States: AStakeholder Analysis’, Special Research Paper.
– Pharmacies. Benefits to pharmacies are relatively
only the transactions costs and extra capital expenditure for setting up the distribution network.
– Health insurance schemes. Table 1 also outlines
Efficiency gains
cost savings for health insurance systems. Parallel Efficiency gains in production are another potential imported drugs are sold at a lower price to the source of benefits of parallel trade. Those benefits could end-consumer, which reduces the costs to health potentially accrue in a situation of international arbitrage.
insurance systems. Cost savings to health insurance However, this is less likely to arise in the pharmaceutical systems are likely to be passed on to tax payers sector. The reason for this is that prices in exporting countries are not lower because of more efficientproducers, but because of different regulatory – End-consumers. Direct benefits for patients from
approaches to pricing. Parallel trade therefore does not parallel trade depend on the structure of cost-sharing appear to promote efficiency gains in production in the systems in the respective countries. In co-payment usual way of placing pressure on costs. In fact, it could systems, customers contribute to total healthcare increase real social costs as additional transportation expenditure by making a small payment. Parallel trade Shortage of supply in the exporting country
The overall finding of the LSE study is that the Another potential effect besides possible price reductions pass-through rate of wholesale price reductions to is a shortage in supply in the source country.11 end-consumers is relatively low. Parallel traders are Pharmaceutical companies are required to supply all EU shown to maximise their profits by placing parallel Member States, whereas parallel importers serve only imported products on the market at a slightly lower price those countries offering attractive profit margins. In low- than the locally sourced product. In the GSK Greece price countries, manufacturers may sell part of their case, the ECJ also found that a large proportion of the goods to parallel traders which export the goods to other price differential is taken up by intermediaries.9 countries. Demand in low-price countries might thereforenot be met even though manufacturers fulfil their An interesting question is whether the high proportion of requirements. Demand in the exporting country may not benefits accruing to the traders reflects some degree of be met in full if parallel traders find it more profitable to market power. A potential reason for such market power sell drugs abroad than in the source country. That could be caps on the amounts which can be exported.
parallel imports may therefore lead to shortages in An alternative explanation could be that the margin exporting countries was also found by the ECJ.12 earned by the parallel importer is a normal profit, Reduction in manufacturers’ marginal
representing the set-up of the trading and distribution investment incentives into R&D
network. In the latter case, the size of the regulatory An important question yet to be explored in the economic differences creates just enough arbitrage opportunity to literature is to what extent a limitation of parallel trade generate trading opportunities, but it is sufficient to cover would increase future R&D investment, if at all. Sunk Oxera Agenda
October 2008
investment in R&D forms a significant part of levels. This problem is not unique to the pharmaceutical pharmaceutical companies’ overall costs. R&D is a form sector. So is it necessary to create sector-specific of joint cost incurred by pharmaceutical companies that competition rules for dealing with parallel trade in this operate globally, such that these costs cannot easily be sector? Can we find a solution with the help of attributed to a particular country. Parallel imports reduce the profits of manufacturers in high-cost countries, which,in turn, may limit manufacturers’ marginal ability to The welfare effects of parallel trade are ambiguous. On the one hand, it reduces prices for drugs in high-costcountries. On the other, it may create a shortage in Conclusion
supply in the exporting country and reduce marginal At the heart of the policy debate surrounding parallel investment incentives of manufacturers. The recent ECJ trade in drugs lies the peculiarity that the principle of a judgment tries to strike the right balance by allowing single European Market strives towards uniform price refusal to supply wholesalers/traders whose demand is levels, while Member States regulate prices at different out of the ‘ordinary’. This debate is likely to continue. Oxera Economics Council, September 15th 2008
These issues, along with others relating to the
and Statistics (ECARES), Université Libre de Bruxelles;
pharmaceutical industry, were discussed during the
Estelle Cantillon, Université Libre de Bruxelles; Eric van
second Oxera Economics Council meeting in Brussels on
Damme, Tilburg University; Jordi Gual, Caixa d’Estalvis i
September 15th. The Council seeks to provide economic
Pensions de Barcelona and IESE Business School,
insight into challenging issues faced by governments,
Barcelona; Bruno Jullien, Toulouse School of Economics;
regulators and business in the context of public policy in
Patrick Legros, ECARES, Université Libre de Bruxelles;
competition and regulation.
Massimo Motta, European University Institute, Florence;
and by two guest participants, Pat Treacy, Partner,
At the meeting, Oxera economists were joined by fellow
Bristows, and Vincent Verouden, Chief Economist Team,
Council members Mathias Dewatripont, Chairman,
DG Competition.
European Center for Advanced Research in Economics
See www.oxera.com for more information.
1 EFPIA (2008), ‘The Pharmaceutical Industry in Figures’, European Federation of Pharmaceutical Industries and Associations, p. 3.
2 Ganslandt, M. and Maskus, K.E. (2004), ‘Parallel imports and the Pricing of Pharmaceutical Products: Evidence from the European Union’,
Journal of Health Economics, 23, March 17th, pp. 1035–57.
3 This was confirmed by a price comparison of 19 pharmaceutical products in 14 European countries undertaken by the London School of
Economics. London School of Economics (2004), ‘The Economic Impact of Pharmaceutical Parallel Trade in European Union Member States: A
Stakeholder Analysis’, Special Research Paper, January, Table 3.2.
4 Mrazek, M. and Mossialos, E. (2004), ‘Regulating Pharmaceutical Prices in the European Union’, in Regulating Pharmaceuticals in Europe:
Striving for Efficiency, Equity and Quality, Maidenhead: Open University Press, pp. 114–29.
5 OHE Consulting (2005), ‘The Many Faces of Innovation’, February 18th.
6 Judgment of the Court (Grand Chamber) (2008), Article 82 EC – Abuse of dominant position – Pharmaceutical products – Refusal to supply
wholesalers engaging in parallel exports – Ordinary orders, In Joined Cases C-468/06 to C-478/06, September 16th, recital 67.
7 London School of Economics (2004), op. cit., p.15.
8 Ibid. p. 58.
9 Judgment of the Court (Grand Chamber) (2008), Article 82 EC – Abuse of dominant position – Pharmaceutical products – Refusal to supply
wholesalers engaging in parallel exports – Ordinary orders, In Joined Cases C-468/06 to C-478/06, September 16th, recital 54.
10 Danzon, P. (1997), ‘Price Discrimination for Pharmaceuticals: Welfare Effects in the US and the EU’, International Journal of the Economics of
Business, 4:3, pp. 301–21.
11 Kanavos, P.G. and Costa-Font, J. (2005), ‘Pharmaceutical Parallel Trade in Europe: Stakeholder and Competition Effects’, Economic Policy,
20:44, October, pp. 751–98.
12 Judgment of the Court (Grand Chamber) (2008), Article 82 EC – Abuse of dominant position – Pharmaceutical products – Refusal to supply
wholesalers engaging in parallel exports – Ordinary orders, In Joined Cases C-468/06 to C-478/06, September 16th, recital 43.
Oxera, 2008. All rights reserved. Except for the quotation of short passages for the purposes of criticism or review, no part may beused or reproduced without permission.
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October 2008
If you have any questions regarding the issues raised in this article, please contact the editor,
Derek Holt: tel +44 (0) 1865 253 000 or email d_holt@oxera.com
Other articles in the October issue of Agenda include:
state aid and the banking crisis
time and timing in capital markets: implications for pensions investment
what we talk about when we talk about consumer welfare
Phil Evans, FIPRA
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