Parallel Trade and the Pricing of Pharmaceutical Products

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Parallel Trade and the Pricing of Pharmaceutical
Products
Conference on Health Economics and the
Pharmaceutical Industry

• Frank Müller-Langer

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Agenda

• 1 Introduction
• 2 Prior literature
• Double marginalization model with complete
  information
• Conclusion and ideas for further research

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Parallel imports (PIs)

• When do parallel imports actually occur?
• Why should we care about parallel imports?
• - Advocates of strong patent rights for new
  pharmaceutical products support a global regime
  of banning parallel imports
• - Restraints on parallel imports vary widely
  between developed and developing countries and
  even amongst developed countries

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Questions to be analyzed

• Why may parallel imports actually occur in
  equilibrium when information is complete?
• Are parallel imports beneficial or detrimental to
  the producer of a patented product?

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Agenda

• 1 Introduction
• 2 Prior literature Determinants of parallel
  trade
• Double marginalization model with complete
  information
• Conclusion and ideas for further research

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Determinants of Parallel Trade

• First strand of literature
• Exclusive distribution rights in foreign
  markets, vertical price control and parallel
  trade Maskus and Chen (2002, 2004)

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Determinants of Parallel Trade

• Second strand of literature
• Price regulations by national governments and
  parallel trade Ganslandt and Maskus (2004),
  Jelovac and Bordoy (2005)

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Agenda

• 1 Introduction
• 2 Prior literature
• Double marginalization model with complete
  information
• Conclusion and ideas for further research

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Double Marginalization Game Assumptions

• Player 1 Monopolistic manufacturer of
  pharmaceuticals in country A
• Manufacturer has marginal costs of zero
• Player 2 Exclusive distributor in country B
• Players payoff functions their profits
• Demand in country A
• Demand in country B
• Parallel imports are allowed (perfect substitute)
• Distributor marginal costs of parallel trade,

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Structure of the game

• First stage manufacturer chooses the wholesale
  price at which he sells the pharmaceutical
  product to the distributor in country B,
• Second stage distributor chooses the retail
  price in country B, pB
• Third stage manufacturer and distributor
  simultaneously choose the prices at which they
  sell the product in country A in a Bertrand price
  competition, and .

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Bertrand price competition

• Rules of the game
• The low-price firm serves the entire market
• The high-price firm sells nothing
• Manufacturer has marginal costs of zero
• Distributor has positive marginal costs of
• Manufacturer sets a price that is smaller than
  the marginal costs of the distributor,

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Bertrand price competition
Result PIs will never occur in any sub-game
perfect Nash equilibrium in the double
marginalization game with complete information
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Distributors decision

• In the second stage, the distributor anticipates
  that he will be driven out of the market in
  country A in the third stage
• In the second stage, the distributor sets a
  retail price in country B that is 50 per cent
  higher than the wholesale price set by the
  manufacturer

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Maximization problem of the manufacturer
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Solution 1 for low trade costs and high

• We use the Kuhn-Tucker Theorem and obtain two
  solutions
• Solution 1
• Solution 1 only satisfies the non-negativity
  restrictions
• if

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Solution 2 for

• equal to the monopoly price in the double
  marginalization game when parallel imports are
  prohibited
• equal to the profit-maximizing wholesale price in
  the double marginalization game when parallel
  imports are prohibited

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Equilibrium Quantities and Prices
PIs allowed PIs prohibited
Price in A
Quantity in A
Wholesale Price in B
Retail Pr. in B
Quantity in B
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Profit of the manufacturer

• Parallel imports are allowed
• 2. Parallel imports are prohibited

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Net effect on profit when PIs are allowed

• and
• and as b gt0.

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Net effect on profit when PIs are allowed

• For we obtain
• Hence,
• Result Manufacturer generates a lower profit
  when parallel imports are allowed

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Results of the welfare analysis

• The net effect of parallel trade on global
  welfare is positive if the market in country A is
  large
• ( )
• The net effect of parallel trade on global
  welfare can be negative if trade costs are at an
  intermediate level and countries are virtually
  homogenous in terms of market size ( )

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Summary of the main results

• PIs will never occur in a double marginalization
  game with complete information
• If , potential competition
  from parallel trade does not arise. The
  manufacturer charges the monopoly price in
  country A and the optimal wholesale price in
  country B
• If , potential competition from
  parallel trade arises. The manufacturer
  strategically sets the wholesale price in country
  B and the price in country A, in order to prevent
  that parallel trade occurs

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Summary of the main results

• The manufacturer generates a lower profit when
  parallel imports are allowed as he has to set
  prices strategically in order to deter parallel
  imports

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Agenda

• 1 Introduction
• 2 Prior literature
• Double marginalization model with complete
  information
• Ideas for further research

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Ideas for further research

• Does parallel trade occur when country A is less
  attractive in terms of market size,
  , and trade costs are very low
• ?
• Impact of a price cap in country B?

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Ideas for further research

• Parallel trade and medicines for neglected
  infectious and tropical diseases
• - 99 per cent of global demand for medicines
  for such diseases is generated in the developing
  world
• - Country A high-income country
• - Country B low-income country

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• Thank you

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Follow-up paper New timing of the game

• Stage 0 Manufacturer chooses retail price in
  country A
• Stage 1 Manufactuer chooses wholesale price in
  country B
• Stage 2 Distributor chooses retail price in
  country B
• Stage 3 If , a third firm will
  enter the market, buys the product from the
  distributor in country B and then re-sells the
  product in country A

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Game with asymmetric information

• First stage Manufacturer chooses the price at
  which he charges the distributor in country B
• Second stage Nature chooses the demand in
  country A and country B
• Third stage Distributor chooses the price he
  charges his customers in country B
• Fourth stage Manufacturer and distributor play a
  Bertrand game

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Hypothesis

• Depending on Natures choices with regard to
  local demand functions parallel imports may occur
  in equilibrium

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Social welfare analysis of parallel imports

• Infectious diseases kill 14 million people around
  the world every year, with 90 per cent of those
  deaths occurring in the developing world
• Furthermore, almost 1,400 new medicines have been
  developed in the last 25 years, but only 1 per
  cent of these were medicines for parasitic and
  infectious tropical diseases that are rampant in
  the developing world

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Hypothesis

• Hypothesis There is an important rationale for
  restricting parallel importation of medicines for
  parasitic and infectious tropical diseases that
  are rampant in middle income and low income
  countries
• Parallel imports would further reduce the
  incentives to invest in RD for medicines for
  parasitic and infectious tropical diseases

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Parallel Imports and the WTO

• WTO members are free to choose whether to allow
  or prohibit parallel imports
• Article 6 of the TRIPS Agreement
• For the purposes of dispute settlement under
  this Agreement, subject to the provisions of
  Articles 3 and 4, nothing in this Agreement shall
  be used to address the issue of the exhaustion of
  intellectual property rights.

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Distributors decision

• In the second stage, the distributor anticipates
  that he will be driven out of the market in
  country A in the third stage
• Parallel trade does not occur
• Total profit is equal to the profit generated in
  country B through exclusive distribution

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Distributors decision

• The distributor has to pay the wholesale price
• Maximizes profit according to

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Distributors decision

• The first-order condition is given by

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Parallel trade can have a negative effect on
global welfare , and