Eur J Health Econ (2008) 9:185–191 DOI 10.1007/s10198-007-0059-0
ORIGINAL PAPER
The impact of generic substitution on price competition in Finland Ville Aalto-Seta¨la¨
Received: 31 October 2006 / Accepted: 19 April 2007 / Published online: 17 May 2007 Springer-Verlag 2007
Abstract Generic substitution by pharmacists was introduced in April 2003 in Finnish pharmaceutical markets. This article examines the impact of generic substitution on price development. This study examined all of the 2,100 substitutable drugs in Finland. The impact of generic substitution on price competition was significant. The average price of substitutable drugs decreased by more than 10%. However, the price development was uneven; some prices increased whereas others decreased by more than 50%. The most important factors that influenced the price development were the number of competitors, whether the drug was originator or generic and the width of the price band. Keywords Generic substitution Pharmaceutical industry Price competition JEL codes
D43 L65
Introduction The current costs of prescription drugs and their trajectory raises concerns throughout the industrialised world. In European countries, pharmaceutical costs account for approximately 10% of total healthcare costs and are the fastest growing expenditure category within healthcare budgets [8, 15]. There are at least three reasons for increasing costs—price increases of pharmaceuticals, spending on new products and increased volume [2].
Generic substitution is one policy option that public sector payors have used in different countries to reduce the cost of pharmaceuticals. Generic substitution reduces the costs of substitutable drugs in two ways. First, pharmacies substitute higher priced brand name drugs with less costly generic versions. Second, generic substitution may foster competition between the original manufacturers and the manufacturers of generic substitutes. The amount of cost savings due to substitution in pharmacies is quite obvious. Savings because of increased price competition are far from clear. However, according to the Social Insurance Institution Finland (KELA), two thirds of the total national savings due to generic substitution were attributable to price competition and one third to the actual substitution of prescription drugs in pharmacies during the first year of generic substitution [12]. In Finland, the effect of price competition was a larger source of savings than was the actual substitution. This study examines the effect of generic substitution on price competition and price development during the first year of generic substitution. Detailed monthly micro level data about prices and dispensed quantities of all substitutable drugs in Finnish pharmaceutical markets facilities the analysis. Further, there is price competition only between pharmaceutical companies but not between pharmacies in Finland. All of the pharmacies are regulated to charge the same price.
Finnish pharmaceutical markets V. Aalto-Seta¨la¨ (&) Faculty of Pharmacy, University of Helsinki, P.O. Box 56, 00014 Helsinki, Finland e-mail:
[email protected]
In principle, manufacturers are able to decide the prices of their drugs in Finnish pharmaceutical markets. In practice, however, the market is regulated because the maximum
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wholesale prices of prescription drugs, which are reimbursed by the government, are determined by negotiations between the producers and the regulatory authority. The regulatory authority sets the maximum wholesale price and the retail mark-up for reimbursed drugs. Further, manufacturers have to sell the drugs with the same wholesale prices to all pharmacies and the pharmacies have to charge the wholesale price plus the fixed markup. There is no competition between pharmacies because entry is also strictly restricted. One consequence of the Finnish regulatory system is that manufacturers decide the wholesale price (maximum regulated price or lower), charge it from all pharmacies and all of the pharmacies charge the same price. Once the price has been set, the regulatory authority will not, in general, allow large price increases. The Finnish pharmaceutical market does not have a reference pricing system. The prescription drug is reimbursed with the same percentage, though it would be a lot more expensive than a generic substitute. Generic substitution Generic substitution means that the pharmacist replaces an original drug by a generic product with an equivalent product in terms of active ingredient strength, dissolution and bioavailability. These products form one substitution group. The obligations of the pharmacist to substitute vary according to legislation in each country. In Finland, the pharmacist has to suggest substitution of the original drug if the original drug is not already located in the price band. The lower limit of each price band is the price of the least expensive product in the substitution group. If the least expensive price is under 40e, the upper limit of the band is 2e above the lowest price. If the least expensive price is 40e or more, the upper limit is 3e above the lowest price. The purpose of the price band is that, if the pharmacy runs out of the least expensive product, it is able to sell some other moderately priced product. Another outcome of the price band is that the patient is able to continue to use the brand name drug if it is located within the price band. Table 1 The extent of generic substitution (April 2003–March 2004) following implementation of the law regarding generic substitution (source: Social Insurance Institution of Finland (KELA), Medicines Act 80/ 2003)
a
Assuming that all of the substituted drugs are located outside the price band
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The negative side of the band is that pharmacists would maximise profits by selling the most expensive drug within the price band (because of fixed retail prices and markups in Finland). However, according to estimated demand models, pharmacists have not attempted to maximise profits by dispensing the most expensive drug within the price band but have behaved ethically and have generally dispensed the cheapest drug [13]. The physician or patient also has the right to refuse to accept a generic drug. The pharmacist does not generally inform the physician about the replacement. So, if the physician wants to deny the replacement, he or she has to do it in advance. Since the introduction of generic substitution, physicians have mainly written prescriptions for pharmaceuticals that are already within the price band (Table 1). If the prescribed drug has not been in the band, it has been replaced in about half of the cases. The most common reason for non-replacement by a pharmacist has been because the consumer has denied the replacement. Physicians have denied the replacement very rarely. Another important fact from Table 1 is that, in about 10% of the cases, the dispensed drug has been outside the band. The markets of substitutable drugs have two separate submarkets: a competitive market within the price band and a market for high priced branded drugs outside the price bands.
Methods and data This study examined the price development of substitutable drugs in Finland from March 2003 to April 2004. The study data is monthly package level micro data on prices and quantities. The data include price and monthly sold quantity information of each item of substituted drugs in pharmacies. The Finnish Association of Pharmacies provided price data and the National Agency for Medicines the quantity data. Price data is public but monthly sold quantities are confidential. The data include the number of competitors in each substitution group. Thus, the structure of the substitution group was known. The data also include information about
Substituted drugs
Share of all substitutable drugs (%)
Share of drugsa outside the band (%)
12.6
48.3
No substitution Prescribed drug located inside the price band
73.9
Consumer objected to the replacement
10.7
41.0
Doctor objected to the replacement
0.4
1.5
Other (drug inside the band not available or prescription written before 1.4.2003)
2.5
9.6
The impact of generic substitution on price competition in Finland
the brand name drug in each group. Lastly, it was considered whether or not it was possible to purchase the drug without a prescription. This prescription indicator is an important variable in the empirical analysis. If a patient buys the drug without a prescription, the pharmacist may suggest a replacement but he or she is not required to do so (though the price of the drug was above the price band). Descriptive statistics There were 2,082 substitutable drugs available in Finland in April 2004. This study did not examine drugs by which the patent expired during the study period. There were 502 potentially substitutable drugs by which there was no generic competition during the study period. These drugs faced only potential but not actual competition. At the other extreme, the maximum number of products in one group was 11. Table 2 reveals the importance of the number of competitors for price development. The average price decrease is 10.6%. If there are, for example, three competitors, the average price decrease has been ‘‘only’’ 6.6%. However, if there are seven or more competitors, the average price decrease has been more than 30%. The table also reveals that most of the drugs are within the price bands. This is natural, by definition, in the case of small substitution groups. In larger groups (at least five products), 55–75% of the products are within the price band.
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of the prices of the group declined sharply within the study period. The largest price reductions in the substitution group have been about 80%. It seems that firms have two possible pricing strategies: set the price inside the band (drugs 5–11) or as high as possible (drugs 1–4). If the price is above the band, the drug is consumed by only those who deny the replacement. As described previously, in most cases, consumers deny the replacement. In these cases, demand was inelastic and, thus, the price is set as high as possible. Thus, there looks to be two quite separate submarkets inside the substitution group. Example: ranitidine The second example is the substitution group containing the active ingredient ranitidine (Fig. 2). The group included nine competitors but the average price of the group has not decreased the same extent as enalapril. There are two potential reasons for the different price development.
Example: enalapril The first example is the substitution group where the therapeutic ingredient is enalapril (Fig. 1). This group includes the most competitors—11. Figure 1 shows the price development of all of the drugs in the group and also the upper limit of the price band (the lower limit of the band is the price of the cheapest drug). The figure reveals that most Table 2 Number of drugs in substitution groups at April 2004
No. of drugs in the groups
Fig. 1 Price development in the substitution group enalapril (5 mg, 100 tablets)
No. of products
No. of groups
Share of products within price band (%)
1
502
502
100.0
–1.5
2
564
282
90.2
–3.5
3 4
330 140
110 35
82.7 82.1
–6.6 –14.9
5
125
25
74.4
–17.2
6
114
19
78.9
–21.1
7
98
14
74.5
–32.3
8
88
11
75.0
–34.7
9
90
10
68.9
–36.2
10
20
2
65.0
–52.5
11
11
1
54.5
–42.2
86.6
–10.6
Average
Average price change (%)
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Firstly, the fixed 2e-wide price band was wide in relative terms. There were few incentives to lower prices because nearly all of the drugs were within the band. Another reason is that it is also possible to buy ranitidine without prescription. If the drug is bought without a prescription, the pharmacist is not required to suggest the replacement, even if the price of the drug is above the band. This also decreases incentives to lower prices. Example: ibuprofen The third example is the substitution group containing the active ingredient ibuprofen (Fig. 3). This group included only two competitors. The outcome in this group was that both of the drugs were inside the price band. The difference in the cost of the drugs was 1.83e. It is notable that the price of the brand name drug was lowered twice to be priced under the upper limit of the price band (2e more than price of the generic competitor). The average price of the substitution group decreased marginally.
Fig. 2 Price development in the substitution group ranitidine (150 mg, 10 tablets)
Fig. 3 Price development in the substitution group ibuprofen (200 mg, 10 tablets)
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Empirical analysis Table 2 and the examples above have illustrated the determinants of price development: the number of competitors within the substitution group, the relative width of the price band and the prescription versus non-prescription status. To obtain a more accurate picture of the price development, a regression analysis was performed where the dependent variable was the price index of the drug. The base period of the index was March 2003 (immediately before the substitution was introduced) and the period we were examining was April 2004 (one year later). Because the value of each price index is 100 in March 2003, the interpretation of the regression coefficients is straightforward. A simple model was estimated, where price development was explained by the number of competitors and indicator variable if the drug was the most expensive in its substitution group before the generic substitution started. This indicator variable is a proxy for brand name drugs. A prescription indicator was also included. It tells us whether it is possible to also purchase the drug without prescription. (If the drug was bought without prescription, the pharmacy was not forced to suggest a substitution.) The substitution groups were divided into four categories based on the average price of the substitution group before the generic substitution. The groups were: average price under 6e, average price between 6e and 12e, average price between 12e and 18e, and average price over 18e. The reason to divide substitution groups into four categories was that the fixed width of the price band—2e or 3e—causes the relative width of the band to be different in the substitution groups of different average prices. The important issue in the estimation is the exogeneity of the number of competitors in the substitution group. It is clear that the number of competitors in markets is not generally exogenous. It may be affected by profit possibilities in the market. In this data, the situation may be different because maximum prices are regulated and these prices were charged before the generic substitution took place. However, it is not guaranteed that this regulation was successful. If the regulation has not been successful and a high number of competitors is due to high prices in the substitution group before the substitution, then ordinary least squares (OLS) may be a biased estimation method. This limitation may be overcome by instrumenting the number of competitors by sold quantities. In other words, the number of competitors is not used as an explanatory variable itself but instead the predicted number of competitors based on the size of the substitution group (sold quantity) is used. Thus, the estimation method is two stages least squares (2SLS), which should produce unbiased estimation results.
The impact of generic substitution on price competition in Finland
The number of competitors is inversely related to price change (Table 3). However, the magnitude of the impact is different due to the original average price of the group. If the average price of the group was under 6e, one additional competitor decreased the price by ‘‘only’’ 1.6% (and the coefficient was not statistically significant). If the average price was between 6e and 12e, one competitor decreased the price by 3.4% (p < 0.01). After that, an additional competitor decreased the price level by 4.5% (p < 0.01). An interpretation is that the constant width of the price band made the groups of lower average prices less competitive. A reason for this is that the price bands were very wide in relative terms in the groups of low average price. For example, if the lowest price in the group is 4e, the upper limit of the band is 6e. This was as much as 50% more than the lowest price. Thus, the price band did not create an incentive to lower the price in the groups of low average price, because, roughly speaking, all of the competitors were located inside the band. On the other hand, if the lowest price of the group was more than 100e, the width of the band was less than 3% of the lowest price (the lowest price of 9% of the groups is more than 100e). The analysis shows that the price development of brand name drugs has been different to the price development of generic drugs. Further, the price development of brand name drugs depends on the size of the substitution group. In small substitution groups (number of competitors less than or equal to four), the data suggest that the prices of brand name drugs have decreased more than the prices of generic products (although this was not statistically significant). The situation was very different in large substitution groups. In these groups, the prices of brand name drugs have decreased substantially less than the prices of generics (p < 0.01). An interpretation for different patterns of price development of brand name drugs is that the
Table 3 Factors affecting the price development of substitution groups (N = 1,011) Independent variable
Dependent variable: price index Coefficient
Constant
T-value
102.9
Number of competitors (average <6e)
–1.63
–1.70
Number of competitors (average 6–12e) Number of competitors (average 12–18e)
–3.40* –4.44*
–3.72 –4.77
Number of competitors (average >18e)
–4.59*
–5.89
Brand name (no. of competitors >4)
7.11*
3.22
Brand name (no. of competitors £ 4)
–3.26
1.20
Prescription indicator
–3.26*
–2.77
R
2
* Statistically significant at the level p < 0.01
0.41
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average price of the group has not decreased considerably in small substitution groups and, thus, brand name drugs have reached the price band by quite a moderate price reduction. Instead, the average prices of larger substitution groups have decreased considerably and, thus, the prices of brand name drugs would reach the price band only with a large price reduction. Thus, the prices of many brand name drugs have not decreased at all. The consumer denied replacement of the drug in about 10% of all dispensed substitutable drugs. Brand name drugs outside the price band account for this 10% of the market. Though this market is relatively small, the mark-ups may be very large (see Fig. 1). Lastly, the prescription indicator was an important variable in the analysis. The prices of prescription-only drugs decreased by 3% more than the prices of drugs also sold without prescription.1 There are two possible interpretations about the result. Pharmacies may not suggest a replacement (at least not always) when the substitutable drug is dispensed without a prescription. Another interpretation could be that consumers have stronger brand preferences when the drugs are bought without prescription. This is possible because these drugs are advertised for consumers, unlike drugs sold only by prescription. This creates an incentive for manufacturers to charge a higher price for those drugs.
Concluding remarks This study analysed the price development of substitutable drugs in Finland during the first year of generic substitution. The Finnish generic substitution is powerful in a sense that a pharmacist has to replace the original brand name drug by a generic version if it is not cheap enough itself and if the patient or physician does not refuse the replacement. Our analysis showed that generic substitution succeeded in triggering price competition between substitutable drugs in Finland. The average price reduction of substitutable drugs was 10.6% during the first year of generic substitution. However, the variation in price development was very large: the prices of some drugs increased whereas the prices of other drugs decreased by more than 80%. The main determinant of the price development in the substitution group was the number of competitors. Greater price decreases were observed in absolute and relative terms in high priced substitution groups than in low priced substitution groups. The most probable reason 1
Typically, substitutable drugs are sold only with prescription. However, it is possible to buy some drugs, for example, quite mild dosages of some active ingredients like ibuprofen and ranitidine, without prescription.
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for this is the formulation of price bands. Two euros (2e) appeared to be too wide a price band for low priced substitution groups to create incentives for price competition. Also, prescription indicator affects the price development of substitutable drugs: if drugs are sold only with prescription, prices have decreased about 3% more compared to products also dispensed without prescription. There were important differences in the price development of brand name and generic drugs. The prices of brand name drugs have decreased less than the prices of generic competitors in large substitution groups. There were two submarkets inside some large substitution groups: generic products inside the band and higher priced brand name drug(s). Earlier studies have revealed similar results related to market segmentation. Results from studies conducted in the US show that the price difference of brand name and generic drugs usually remain high, even though there are less expensive products available. There is often continuing demand for high priced branded products [4, 9]. Our results show that the markets were not segmented into small substitution groups. The data suggest that the prices of brand name drugs decreased more than the prices of generics in small substitution groups. The reason for the different price development in small and large substitution groups may be that the prices of generics have not decreased a lot in small groups and, thus, the prices of brand name drugs are within the price band after a small price reduction. According to our estimates, in substitution groups of four or less competitors, the markets are not segmented but the prices of brand name drugs have decreased more than the prices of generics. Interestingly, the same kinds of results have been found in Canada. According to Lexchin, having four or more generics available was associated with a rise in the price of the brand name drugs compared to the situation where there was a single, two or three generic competitors [11]. Generic substitution has had a large effect on price competition in the Finnish pharmaceutical market. Thus, it can be said that generic substitution has been successful in Finland. However, there are further possibilities to enhance competition in the markets of substitutable drugs. There is a lot of variation in the markets of generic drugs between countries. The average price differential between generics and brand name drugs vary from 20% to 80% between countries [6]. The US pharmaceutical market has the longest experience of large-scale generic competition. The results from the US show that the price difference of brand name and generic drugs is usually high. The European results on generic competition are diverse. In some countries, like the Netherlands and Norway, generic substitution has launched tough price competition [3, 5] but in some countries, like Belgium and Italy, the impact of generic substitution has been smaller [10, 14]. The impact of
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generic drug competition on the market share of brand name drugs is unclear [1, 7]. These mixed results suggest that market design has a very important role in pharmaceutical competition. The results vary between countries because regulation concerning generic substitution and, more generally, generic drugs varies between countries. The results of the study indicate that generic substitution has been successful in Finland: generic substitution has triggered price competition and reduced the costs of substitutable drugs. The most obvious way to enhance the competition further in Finland would be to make the price bands narrower in low priced substitution groups. There should be several widths of band—for example, from 50 cents to 5e—or the width of the band should be a function of the lowest price—for example, 10% for drugs under 8e and 5% above that. An additional problem to solve is how the prices of some very expensive brand name drugs would decrease. It should also be mandatory for pharmacists to suggest a replacement, even though the drug was bought without prescription. Generic substitution is an important way to enhance competition in pharmaceutical markets. However, the regulation of markets is an important determinant of market outcome. Thus, we need more research about generic substitution. Very detailed data sets make future research possible in Nordic countries. To achieve the total picture regarding generic substitution demand systems, price elasticities within and between therapeutic ingredients should be examined. Another interesting topic would be the impact of reference pricing on price competition. These topics are left for future research. Acknowledgements This study was conducted while the author worked as Head of Research for the National Consumer Research Centre (Finland) and Professor of Pharmacoeconomics at the University of Helsinki (Finland). The research did not receive external funding. The author thanks Alan Lyles and Simon Bell for their helpful comments and Paavo Saarinen for data assistance. The author is grateful to the Association of Finnish Pharmacies and the National Agency of Medicines (Finland) for providing the data sets for the research. The author has no conflicts of interest directly relevant to the content of the study.
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