Allegations of generic drug price fixing are troubling

NPR’s recent story about alleged collusion among certain generic drug manufacturers is somewhat surprising given the market’s structure and pricing dynamics. Generic drugs are sold on the basis of intense price competition amongst manufacturers and suppliers.

As the number of generic products increases, prices drop precipitously in a matter of months, offering substantial cost savings to wholesalers, pharmacies, hospitals and clinics. It is not uncommon to see the average price of a commonly available generic drug to fall 80 to 90 percent off the previously patented prescription drug’s list price.

{mosads}At this point, the generic drug is a commodity product and is not differentiated in the minds of buyers, health providers, public and private third-party prescription drug payment programs, and the public. Sales and market expenses of a commodity product are essentially nil, and prices are only slightly above manufacturing and distribution costs.

It is true that price of certain products will spike, but the spikes are temporary and limited in duration. Typically, price hikes are due to generic producers dropping out of the market and leaving only a few manufacturers or suppliers.

Disruptions in the availability of intermediate chemicals used in the manufacturing of finished drug products also occur. The supply of generic drugs can also result from manufacturing plant quality control problems and finally, company’s strategic decisions in managing its product line may result in shifts away from less profitable generics to more profitable ones.

Each of these reasons for pricing hikes is understandable in that they represent reasonable causes for aberrant price increases. In a competitive market firms will enter and leave specific markets in response to commercial attractiveness and potential.

Commodity markets offer little opportunity for price increases, and price levels may prove to be unprofitable for a manufacturer to supply. Intermediate chemicals are sourced in a global market, and supply chain disruptions occur for both market and non-market reasons. Some are temporary as other sources are identified, and the availability of intermediate chemicals continues. Manufacturing problems are inherently far more difficult to solve and are largely responsible for ongoing problems with drug shortages.

Quality issues are not easily resolvable and require regulatory approval before production can resume. Also, companies wanting to enter the generic market acquire Food and Drug Administration (FDA) approval of the physical plant, a regulatory review process that can take up a year to complete. Additional time is also required to bring a plant on line for new production.

The pricing dynamics with the generic pharmaceutical industry are relatively straightforward. When a prescription drug goes off-patent, the first generic producer will receive a six-month market exclusivity from the FDA, meaning, in effect, another generic product cannot enter the market until the exclusivity period expires.

It is a common pricing tactic for the first generic manufacturer to set the price 10-15 percent below the reference price of the branded product. tThe six-month period was set up to encourage generic manufacturers to enter the market rapidly by granting the first entrant a financial incentive to develop generic products quickly. Even at this modest discount off the innovator’s list price, the first generic will take significant market share, and the operating profits will be significant.

Following expiration of the six-month period, other companies rapidly launch generic drugs, and competition is based on price-cutting to generate sales and market share. In a matter of a few months, market prices approach marginal production costs, and prices stabilize at a minimum, or floor, price. When prices reach a minimum, consumers and payers benefit from lower prices. Indeed, it has been estimated that the availability of generic drugs has reduced prescription drug spending and has slowed the annual rate of total expenditures on prescription drugs.

As noted, companies will stop manufacturing or supplying a specific generic drug because it is no longer profitable. As companies discontinue supplying a specific drug, remaining companies can then begin raising prices. In markets characterized by a finite number of large firms, an oligopoly exists, and companies act in response to what the dominant firm does. For instance, the dominant firm may choose to raise prices. It is rational to expect other firms to follow with a similar increase.

Smaller firms in an oligopoly will not cut prices because the dominant firm could drop prices in the short-term that would likely drive one or more of the other smaller firms out of the market. These actions in and off themselves do not constitute collusion in a legal sense. Instead, they represent normal market dynamics of this type of market. Again, opportunistic generic firms will eventually enter these markets, and price competition will resume.

Generic drugs now account for almost 90 percent of all prescriptions dispensed in the U.S. As reported by the Generic Pharmaceutical Association, annual savings to the health care system approached $227 Billion in savings in 2015 and $1.2 Trillion between 2006 and 2015. The value to the U.S. health care system is beyond dispute, which is why the allegations of collusion are troubling given the trust the American public places in its domestic pharmaceutical industry.

Should collusion be proven in a court of law, remedies beyond the criminal punishment of those convicted are necessary to mitigate the likelihood of artificially-induced price hikes occurring in the future.

At the least, manufacturers should be required to disclose in advance that they intend to halt production of a low-cost, commonly available generic drug, and the FDA should be funded to increase regulatory inspection of new manufacturing plants to shorten the time to produce generic drugs. Oligopolistic markets should not be the evolutionary norm in this manufacturing sector.

Robert Freeman, Ph.D., is professor of pharmacy practice and administration at the University of Maryland Eastern Shore School of Pharmacy and Health Professions.