Evergreening insulin and market collusion

Yesterday I posted about price discrimination among pharmaceutical firms. However, engaging in price discrimination requires that firms have market power. One way that get market power is if the government grants them an exclusive licence to sell their product, such as through a patent. That market power is time-limited though, because patents expire. Unless, that is, you can argue that you have discovered a new use for your invention. So, pharmaceutical firms spend a lot of time and effort on trying to find new uses for their drugs (see my previous posts here and here, about Viagra), so that the patent can be renewed. This is called evergreening.

Evergreening is pretty widespread, and not just for well-known brand-name drugs. Consider the example of synthetic insulin, as described in this article by James Elliott and Elizabeth Pfiester:

Why aren’t we seeing more companies making insulin? There are many reasons for this, but patent evergreening is a big one. Patents give a person or organization a monopoly on a particular invention for a specific period of time. In the USA, it is generally 20 years. Humalog, Lantus and other previous generation insulins are now off patent, as are even older animal based insulins. So what’s going on? Pharmaceutical companies take advantage of loopholes in the U.S. patent system to build thickets of patents around their drugs which will make them last much longer (evergreening). This prevents competition and can keep prices high for decades. Our friends at I-MAK recently showed that Sanofi, the maker of Lantus, is no exception. Sanofi has filed 74 patent applications on Lantus alone, that means Sanofi has created the potential for a competition-free monopoly for 37 years.

So, don't expect cheap generic insulin to come onto the market for some time. Elliott and Pfiester also reveal a number of other reasons why insulin is expensive, including:

• Just three firms (Eli Lilly, Novo Nordisk and Sanofi) control over 90% of the insulin market worldwide, giving them a cosy oligopoly and a lack of competition on price;
• Collusion (as you would expect in an oligopoly), such as firms paying others not to enter certain markets ("it is actually legal for one insulin producer to pay another one not to enter the market"); and
• Price fixing (again, what you would expect from an oligopoly).

Evergreening is no surprise, since the incentives for that practice are created by the patent laws. However, taking advantage of market power through colluding on prices or market-splitting is illegal in most Western countries. Given that these practices raise prices, reduce the availability of insulin to patients, and reduce total welfare, it is surprising that the pharmaceutical firms can continue to get away with this. When it comes to health policy, this is surely some low-hanging fruit that can be picked to improve health cost-effectively (at the least, by lowering the cost to health funders, who can then divert more resources to other categories of health spending).

In the U.S. though, one problem that is not acknowledged in the Elliott and Pfiester article is that the health insurers, who fund much of the health system in the U.S., have very little incentive to reduce costs. The insurers don't care if the pharmaceutical firms are driving up prices, because the costs are simply passed onto consumers in higher health insurance premiums.

[HT: Marginal Revolution]

Read more:

• Evergreening viagra, revisited
• Evergreening viagra

Protecting price discrimination in the wake of medical tourism

Price discrimination occurs when a firm sells the same good or service to different consumers at different prices, and where those different prices do not arise from differences in cost to the firm. The firm price discriminates by selling the good or service at a low price to consumers that have relatively elastic demand (those that are very responsive to a change in price), while selling the same good or service at a higher price to consumers that have relatively inelastic demand (those that are less responsive to a change in price).

A good example of price discrimination is in the market for pharmaceuticals (which I've written about before), where firms sell the same drugs in different countries for different prices. In lower-income countries, they typically sell the drugs at lower prices than they do in higher-income countries. Unsurprisingly, those that require the drugs respond to these incentives, as Alex Tabarrok noted last week on the Marginal Revolution blog:

In our principles textbook, Tyler and I open our chapter on price discrimination with the following:

"After months of investigation, police from Interpol swooped down on an international drug syndicate operating out of Antwerp, Belgium.  The syndicate had been smuggling drugs from Kenya, Uganda and Tanzania into the port of Antwerp for distribution throughout Europe.  Smuggling had netted the syndicate millions of dollars in profit.  The drug being smuggled?  Heroin?  Cocaine?  No, something more valuable, Combivir.  Why was Combivir, an anti-AIDS drug, being illegally smuggled from Africa to Europe when Combivir was manufactured in Europe and could be bought there legally?

The answer is that Combivir was priced at $12.50 per pill in Europe and, much closer to cost, about 50 cents per pill in Africa.  Smugglers who bought Combivir in Africa and sold it in Europe could make approximately $12 per pill, and they were smuggling millions of pills."

Instead of smuggling the drugs to Europe, it’s also possible to send the European and American patients abroad. Gilead’s Solvadi, for example, is a very effective drug used to treat hepatitis C. In the United States a course of treatment costs about $85,000 but due to an agreement between Gilead and generic manufactures in developing countries, in Egypt, India and much of the developed world it can be had for less than $1000.

There are several conditions that need to be in place in order to practice effective price discrimination:

1.  Groups of customers that have different price elasticities of demand (heterogeneous demand);
2. Different groups of customers can be identified; and
3. No transfers across submarkets.

When consumers (as medical tourists) are able to travel across borders from higher-income countries to lower-income countries in order to obtain their drugs at a lower price, that violates the third condition and means that price discrimination becomes ineffective (at least, for those consumers that can afford to travel across borders). The last thing you want as a price discriminator is the high-price consumers buying at the low price (or buying from the low-price consumers who are on-selling the product). You'd expect the pharmaceutical firms to act to stop this, and indeed that is what has been happening, as Tabarrok notes:

To prevent resale Gilead requires ID and it labels and tracks every bottle sold abroad:

"[Patient IDs] will be used to put an identifying barcode on the bottles they receive with their name and other info. Not only can the code be used to guarantee only residents of the country get the drugs…the provisions require that patients then return a bottle to get a new bottle and allows them to get only one bottle of their prescription at a time, even though allowing them to get multiple bottles could “ease the burden on patients and health providers,” MSF says."

It's not clear to me how labelling and tracking every bottle sold effectively prevents cross-border sales, unless combined with something else like strict residency requirements (such as those noted in this article). For example, perhaps you have to be a resident of the country you are purchasing the drugs in, or else you have to pay the U.S. price. That would prevent the transfers between the submarkets. Unless, you know, the high-income person pays a low-income local resident to get the drugs for them? That might work in some instances, and it's not clear how the drug companies could effectively combat it.

Price discrimination is hard, but as evidenced by the pharmaceutical companies, enormously profitable even if you can't get it perfectly right.

Domino's' block pricing fail

This week in ECONS101, we covered pricing strategy. I love this topic, not least because it covers material that you typically wouldn't see in an introductory economics textbook. One of the strategies we talk about is block pricing. A firm uses block pricing when it charges a relatively high price until the consumer reaches some threshold, then a lower price for every unit the consumer buys after the threshold. Buy-one-get-one-half-price is an example of block pricing. The idea is to price high for those consumers who don't buy much from you, and lower the average price for consumers who buy a lot (you can see how block pricing works in more detail in this post).

Also this week, we had the first ECONS101 test of the semester, and the tutors and I met up for pizza beforehand. Ordering the pizzas online, the banner ads caught my attention. First, this one:

Value pizzas for $5 each. Seems like a good deal. Then this:

Upgrade to extra large for $3 more. Sounds like an even better deal, right? The extra large gives you 50% more pizza for just $3 more (if you zoom in, you'll see that it's 50% more in the fine print). But wait! If you upgrade a value pizza to extra large, you're paying $3 more, which is an increase in price of $3/$5 = 60%! So, you pay 60% more in order to get 50% more pizza. [*]

It's not quite a two-for-the-price-of-three fail, but it clearly isn't block pricing done right. Unless Domino's is relying on it's customers being somewhat innumerate?

*****

[*] Once you factor in the delivery charge, then maybe this deal pays off for the consumer, because the extra $3 would be less than 50% of the cost including the delivery charge. Similarly, for more expensive pizzas, the extra $3 is less than 50% of the cost. However, for pick up customers collecting value pizzas, it clearly doesn't pay off.

This couldn't backfire, could it?... Vaccine against drug addiction edition

The New Zealand Herald reported today:

A New Zealand scientist is exploring a new vaccine for drug addiction, which would teach our immune system to reject specific drugs before they could trigger highs.

Researchers have been trying, unsuccessfully, to create such an intervention since the 1970s.

Dr Benjamin Compton believed the failures didn't owe to the concept itself, but to the design of the actual vaccines...

Vaccines were one of the most cost-effective and powerful health interventions available, Compton said, and he believed it should be possible to vaccinate against drug addiction...

Compton would initially test his vaccine on mice, and, if he could prove the concept worked, it could be revolutionary.

"This technology will be really helpful for those addicts who want to break free of their addiction. Should that person come into contact with the drug, a vaccine will ensure there is no reward from the drug-taking behaviour."

I don't know about you, but I can immediately see a potential problem with this solution. You might argue that drug addiction is itself a problem. I'd agree, provided the addiction causes some other dysfunction in the addict's life, which causes harm to themselves or to others. One obvious harm to the user themselves is the risk of drug overdose.

As a very simple explanation, drug addiction arises because the drug stimulates the reward centre of the brain, causing a 'high'. The high feels good, and the addict continues to use the drug in order to experience the high they get from it. Over time though, drug users develop some tolerance to the drug, and so they might need to use a higher dose of the drug in order to achieve the same high.

Compton's vaccine would interrupt this process by preventing the drug from stimulating the brain's reward centre, thereby preventing the drug user from achieving the high. It seems like a clear solution to drug addiction, so why would it be a problem?

Let's assume that the vaccine is to be administered to current drug addicts, in order to help cure their addiction. If you interrupt the chemical process that leads the drug to stimulate the reward centre in the brain, then some current addicts who are treated with the vaccine would respond by consuming more of the drug, in order to try to get their high. And if the chemical process that focuses on the reward centre in the brain is different from the chemical process that results in toxic drug overdoses, there is a very real risk that the vaccine could lead to more drug overdoses (or at least, it substantially raises the risk of overdose for those addicts who are treated with it).

Alternatively, perhaps the vaccine is designed to prevent addiction in the first place. Exactly who, among non-drug-users, is going to agree to be vaccinated against drug addiction?

So, the vaccine might reduce drug addiction, but come at the cost of more drug overdoses. You solve one problem, but I would worry that you are creating a problem that is potentially much worse. Sometimes unintended consequences are entirely foreseeable.