External Reference Pricing in Pharmaceutical Industry

Introduction

In the marketing practice, marketers largely focus on four key elements that include the product itself, the price of the product, the place, or the location where the product or service is made available for the customers and the promotional activities that are geared towards creating awareness of the product and informing the target audience about its unique attributes. In all of the four marketing elements, it is only price, which is revenue generating and it plays a crucial role in ensuring that a particular product or service sales in large volumes thereby making a company more profitable.

In the determination of price, various factors come into play and they include cost of producing the product or delivering the service, the economic condition of the target market, competition level in the market, the brand name of the product/ service, and the quality of the product/ service (Baines et al. 2013).

Under competition, marketers tend to consider the price of other competing product/ service whilst setting the new price and this strategy is called external reference pricing. According to Trivedi (2002), the idea behind this pricing strategy is that the price should not be too high or low to the competing products/ services. In the pharmaceutical industry, external reference pricing, is commonly applied in order for the government to tame the prices of pharmaceutical products that are protected by intellectual property rights and even enable the pharmaceutical companies to benefit from a created monopoly arising from the patented drugs.

This present study seeks to investigate the flaws of external reference pricing strategy in the pharmaceutical industry from the point of view of PainCeptor Pharma in Canada, and it will seek to provide a recommendation to the Canadian government on whether to continue using this strategy or not in the pricing of pharmaceutical products.

The case of PainCeptor Pharma in Canada

PainCeptor Pharma is a private Canadian company that specializes in the development of drugs that focus on treating pain by acting on the outside of the central nervous system on the noiceptors. This development strategy acts as a unique and competitive advantage for the company because its drugs focus on avoiding the already known side effects of existing central acting agents.

On the other hand, the Patented Medicine Prices Review Board (PMPRB) is an independent quasi-judicial body that was established by the Canadian parliament in 1987. Therefore, the board regulates the company’s pricing strategy and it recommends the prices for prescription and non-prescription drugs that are sold within the borders of Canada (Ruggeri and Nolte, 2013).

One of the principles of pharmaceutical pricing in Canada by the PMPRB is that if a price is found to be excessive, the Board will call for a public hearing against the company and then order it to reduce its prices or offset some of the excess revenue earned (Ruggeri and Nolte, 2013).

According to Ruggeri and Nolte (2013), the board applies external referencing pricing when a new drug is regarded as a major breakthrough, or there is a significant or moderate improvement on an already existing drug. In such scenarios, the board applies the median international price comparison test. This test considers the prices of other related patented drugs that have the same dosage and strengths that are being sold in seven specific countries that include the United States, the United Kingdom, Germany, Sweden, Italy, France, and Switzerland. The median price calculated from these seven countries determines the maximum average potential price that the board will stipulate for the new or improved drug that has been manufactured by PainCeptor Pharma. If the drug is only in use in less than five countries, the international median price is calculated on an interim basis but it will be subject to a review after three years putting into consideration changes that have occurred on the consumer price index (Ruggeri and Nolte, 2013).

The flaws of the external reference pricing in the context of PainCeptorPharma

One of the main flaws that external reference pricing presents to PainCeptor Pharma is the fact that the PMPRB fails to put into consideration the cost that the private company has incurred in producing a new drug or the cost that it has incurred to improve an already existing drug.

According to the writings by Baines et al. (2013), this contravenes the traditional norm of pricing whereby a price is established after adding the cost of production to the desired mark-up. Failing to put into consideration the cost that has been incurred by PainCeptor Pharma in the manufacturing process creates a possibility that the company may fail to break even or it may earn meager amount of profit that would not be worthwhile considering the amount of investment that has been put forth.

The application of the external reference pricing to a private pharmaceutical company such as PainCeptor Pharma puts it at a disadvantageous position since it has limited investment capital. By having limited investment capital, it means that the private pharmaceutical company is not capable of operating on low profits arising from low pricing and high cost of production whilst there are creditors demanding payments and debtors who are not paying (Kolassa, 2009). Secondly, being a private company, PainCeptorPharma may not be eligible for government subsidies or tax reliefs in certain circumstances when such advantages are only be applied to public or state-owned pharmaceutical companies. Such advantage could have enabled it to operate smoothly even while earning low profits.

In the economics studies presented by Trivedi (2002), he stated that a country, which exercises price control on whatsoever industry, stifles the growth and competition within the aforesaid industry. In this regard, Ruggeri and Nolte (2013) added that through the mandate or actions of PMPRB it is correct to argue that it discourages free economy whereby movement in price is determined by the market forces of demand and supply. The graph demonstrates how in ordinary sense the prices within the pharmaceutical industry should be established. For example, P 1 reflects the price when demand is low but P 2 represent the price when demand is high.

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Figure 1: Forces of supply and demand

Sources: http://www.google.co.ke/imgres?imgurl

By using the external reference pricing, the PMPRB denies PainCeptor Pharma an opportunity to increases its product prices when demand has increased thereby earning additional profits.

According to Hamilton (2008), allowing market forces to establish the prices of pharmaceutical products would encourage competition within the industry, which would lead to the development of highly advanced drugs with greater capabilities in treating diseases, illnesses, or injuries. At the present moment, pharmaceutical companies such as PainCeptor Pharma would shy away from investing much in research and development because developing a superior drug does not guarantee them of generating massive profits since the selling price will be capped by the PMPRB, which creates a possibility for fair-quality drugs being sold at the same price as superior drugs.

Lastly, another flaw associated with external reference pricing is that it assumes the seven countries used in calculating the international median price are experiencing same economic conditions with Canada or in particular, the Canadian pharmaceutical industry. The assumption could create a scenario whereby the PainCeptor Pharma is earning so much profit unlike its counter-parts in the seven countries or it could be earning losses or low profits because the economic condition in the other seven countries is much favorable than that of Canada.

Recommendation

In a bid to encourage competition and even make the Canadian pharmaceuticals industry to be more lucrative to attract many investors, the Canadian government should disband or redefine the mandate of the PMPRB in order to allow market forces of demand and supply to determine the ex-factory prices of drugs produced by pharmaceuticals companies such as the PainCeptor Pharma. However, in order to protect consumers from exploitation, the Canadian government should insist on pharmaceuticals companies to disclose their pricing strategy and reveal the full details of manufacturing cost as well as the mark-up, which should conform to ethical practices and corporate social responsibility standards.

References

Baines, P. Fill, C. and Page, K. 2013. Essentials of Marketing. Oxford, UK: Oxford University Press

Hamilton, R. 2008. Price Image in Retail Management. Michigan, U.S: ProQuest

Kolassa, M . 2009. The Strategic Pricing of Pharmaceuticals. US: PondHouse Press

Ruggeri, K. and Nolte, E. 2013. Pharmaceutical pricing: The use of external reference pricing. Santa Monica, CA: RAND Corporation

Trivedi. 2002. Managerial Economics: Theory & Application. New York, U.S: McGraw-Hill Education

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