In search of the right drug pricing formula

Have you ever wondered why a strip of Augmentin costs Rs 322 while an equivalent brand, Xoclave, is available for just Rs 112? Drug formulations in India often retail for widely different prices, despite there being limited scope for product differentiation. The costliest brand in a drug category is priced up to 20 times higher than the lowest priced brand.

CO-EXISTING BRANDS

In India, branded drug sales are largely driven by what doctors prescribe. Consumers are also reluctant to try a low-cost substitute. However, this trend is changing gradually, as patients are now willing to substitute costlier, prescribed brands with low-cost brands recommended by their chemists. Big pharma and multinationals use their research and development strengths and superior product quality perception as the key differentiator to promote their brands with specialists.

In contrast, smaller companies use price and affordability as the USP to market their brands. They incentivise chemists to encourage substitution of prescribed brands with their low-cost brands.

Why this divergence in pricing?

Cost structure is one key factor determining the price of branded drugs in India. Companies such as Sun Pharma use manufacturing facilities approved by such global regulators as the US Food and Drug Administration and WHO to manufacture drugs for the Indian market. While this ensures superior quality, the cost of maintaining these facilities is substantially higher, resulting in a higher cost structure.

Similarly, different therapies may call for varying sales effort, resulting in selling costs being higher or lower. This leads to differential pricing too. Tax and duty structures also influence pricing decisions. Companies like Torrent Pharma and Sun Pharma, which have set up production bases in tax-free zones such as Sikkim, Jammu and Silvassa, benefit from leaner tax structures and duty exemptions. On the contrary, multinationals such asGlaxoSmithKline Pharma, which outsource a substantial portion of their production to third-party firms, often don't enjoy any tax or excise exemptions. Hence the difference in selling price.

Even as companies might claim cost structure and brand equity as a justification for differential pricing, the current level of divergence seems quite high. In this context, the demand by NGOs like the All-India Drug Action Network to review the pharma pricing policy and put a cap on drug prices assumes greater significance.

Government efforts to curb pricing

One of the efforts to establish checks on drug prices was the Drug Price Control Order (DPCO) of 1995. But it did not meet its objective of ensuring availability of cheap drugs for the masses. The government's assumption that price control would improve access to quality medicines thus turned out to be flawed.

Following this, the Supreme Court directive to the government to bring drugs that figure in the national list of essential medicines (NLEM) under price control prompted policymakers to review the pharma pricing policy.

In response, the Department of Pharmaceuticals (DoP), in November 2011, proposed the National Pharma Pricing Policy (NPPP) 2011.While this was unanimously welcomed by the industry; it was vehemently opposed by civil society groups and NGOs for the reasons discussed below.

The NPPP 2011 proposed that the 348 drugs covered by NLEM would be brought under price control. This will encompass 60 per cent of the Indian pharma market. The policy recommended a shift in the pricing mechanism from a cost-plus basis to market-linked pricing. Under this formula, the average price of the top three brands (by sales) in a given category was to be fixed as the ceiling price. NGOs and other civil society groups have moved the apex court against this methodology as it will prompt players in the lower band of the pricing curve to increase drug prices

An analysis by AIOCD AWACS, a leading industry research firm, estimated NPPP 2011 to impact pharma revenues by 2.5-3 per cent. With the policy now being redrafted, the control on drug prices is expected to be tightened further. Clarity regarding the impact on the industry and specific companies will emerge only after the final contours of the policy are made public. However, if the proposal to bring NLEM-listed drugs under price control is approved, Ranbaxy's key brands, such as Storvas, Sporidex, Volini and Zanocin would come under price control. Similarly, GlaxoSmithKline Pharma's largest brands, Augmentin and Phexin, will come under price scrutiny.

Profitability

Though the revenue impact does not seem material, profitability of these companies may be hit hard, given that domestic formulations constitute the most profitable segment. Operating margins are typically 30-40 per cent for most companies. Key molecules that figure in the revised NLEM list of 348 drugs include Atorvastatin, Amoxycillin + clavulanic acid, Paracetamol, Cefixime and Metformin.

On the apex court's directive, the Department of Pharmaceuticals is currently involved in detailed discussions with all the parties concerned to rework the pricing policy. A final decision on the same is expected in due course. During the discussions, the Health Ministry and the PM's Economic Advisory Council also put forth their views on the pharma policy.

The Economic Advisory Council has suggested that the ceiling price should be the lower of the price paid by the median consumer and the price paid by the 80th percentile consumer. In a simpler formula, the Ministry of Health has proposed a ceiling price which is the average price of the bottom three brands in the respective drug category.

What are the lacunae?

While all this will benefit patients by way of cheaper drugs, it may lead to quality issues as companies may focus more stringently on minimising costs rather than improving efficacy.

Moreover, profits from the domestic market serve as cash chests for large Indian companies with a global presence, like Sun Pharma, Ranbaxy, Dr Reddy's and Lupin, to invest globally in research and development initiatives.

Radical changes in the pricing policy, if effected, in addition to hurting domestic profitability, may impact their ability to pursue export opportunities aggressively.

Apart from the above, the government could consider alternatives such as creating a healthcare fund to procure generic drugs and distribute them to the economically backward sections through primary health care centres.

Expansion of the Jan Aushadhi scheme to more regions of the country will ensure availability of cheaper drugs for the common man. Scrapping of excise and value-added tax on NLEM-listed drugs may help cut prices too.

These, along with the moderation in drug prices, will help the government achieve its objective of making drugs affordable to all.

Price control may not improve access to drugs

With a view to checking drug price increases and to make drugs available to a wider section of patients, the government promulgated the Drug Price Control Order (DPCO) in January 1995. The aim was to control the retail prices of 74 drugs under the order.

The pricing was based on a cost-plus approach wherein manufacturing, packaging and marketing costs, in addition to a nominal margin, were considered in fixing the ceiling price for individual drugs. This policy failed to deliver because of its short-sighted approach. In order to evade price control, companies either completely stopped manufacturing these products or resorted to manufacturing and promoting irrational combinations.

As a result, the manufacture of 29 out of the 74 drugs was discontinued. The policy not only led to drug shortage but also lower benefit to patients, given the irrational combinations. Interestingly, the inflation index of the non-DPCO listed products was much lower at112, vis-à-vis the general inflation index (403) and DPCO product index (151).

This leads one to question the logic behind price control! Does price control improve access and availability? Definitely not, shows this experience. The government should explore better ways to improve access to drugs by patients.

Nalinakanthi.venkataraman@thehindu.co.in