This article, which can be found here,  pursues a comparative analysis of the recent case law on excessive pricing in the pharmaceutical sector, examining in particular the Italian and UK experience.

High Drug Prices

The paper is structured as follows:

Section 2 begins with a brief review of the existing literature on excessive prices in the EU.

This section reviews the arguments for and against competition authorities intervening when prices are too high. On the one hand, it is argued that high prices should not be the subject of competition law intervention because such intervention may affect innovation incentives and dynamic efficiency; because high prices will attract competitors and, hence, will tend to self-correct; because there are high probabilities and costs of mistaken intervention; and because this is a task that should be left to specialised regulators. On the other hand, it is argued that correcting high prices directly increases consumer welfare, which is the goal of competition law; that high prices are not always self-correcting, particularly where high and non-transitory barriers to entry exist; and that, where monopolisation is not caught by competition law, there is a gap that must be filled by sanctioning exploitative abuses.

This debate has led to a cautious approach by antitrust agencies, which either do not pursue exploitative abuses at all (as in the US) or only intervene in exceptional circumstances (as in Europe). Hence, it is not a surprise that the rules applicable to excessive pricing are not very well developed even in Europe which has, since the United Brands case in 1978, deployed a two-prong test to identify anticompetitive excessive prices.

According to this test, first it must established whether the price is excessive through a comparison between the selling price of the product in question and its cost of production, which would disclose the amount of the profit margin. The second step is to determine whether the excessive price is unfair – a topic on which the ECJ did not provide significant guidance. Subsequent case law on the matter is limited, typically concerning markets with a deeply rooted dominant position where entry and expansion of competitors is not expected to introduce effective competition in the foreseeable future.

Section 3 reviews the main features of exploitative pricing conduct in the pharmaceutical sector in Europe, including the two emblematic investigations conducted by the Italian Competition Authority (ICA) and the UK’s Competition and Markets Authority (CMA) regarding excessive pricing of off-patent drugs, i.e. outside the monopoly granted by the patent.

This discussion will be quite long, because I will describe the (complex facts) of these cases here. This will prevent further repetition when reviewing other papers / judgments regarding these decisions.

In Italy, the generics company Aspen acquired from GlaxoSmithKline (GSK) a portfolio of long off-patent anticancer drugs (the ‘Cosmos’ drugs). Aspen bore only distribution costs; it did not invest in R&D nor in promotional activities. Aspen then adopted a very aggressive negotiation strategy towards the Italian Medicines Agency (AIFA), in order to obtain a re-categorization of Cosmos drugs so that they would no longer be subject to the National Health Service’s reimbursement scheme – which would allow the pharmaceutical company to set prices freely. The proposal made by Aspen was not acceptable to the AIFA, as its scientific committee considered the Cosmos drugs to be essential and non-substitutable medicines used for the treatment of cancer for specific categories of patients. Aspen insisted that AIFA either increase the reimbursement rate for the Cosmos drugs or re-categorise them, and proceeded to exert extensive pressure on the regulator through a credible threat of reducing or withdrawing the Cosmos drugs from the Italian market. Aspen finally obtained a price increase of 300% to 1,500% as compared with the initial prices previously charged by GSK.

It is worth mentioning that the Italian NCA identified a strategy by Aspen aimed at increasing prices in several Member States that relied on the creation of artificial scarcity of Cosmos drugs in the markets concerned. It found that Aspen had a dominant position and that, while there were no barriers to entry, entry was doubtful due to the drugs concerned being limited to specific and infrequent diseases, which meant that the dimension of the relevant markets and potential earnings were low. Lastly, it found that AIFA did not have countervailing buyer power because it had to purchase the Cosmos drugs for which there were no alternatives.

The price charged by Aspen was found to be excessive by reference to a variety of methods. First, the authority found that the price was excessive by comparing production costs with sale prices. That this price was excessive was confirmed through application of two distinct methodologies. First, the authority adopted a Gross Margin method, which provided an estimate of excessiveness measured by the percentage Gross Margin (Gross Margin/Revenues %) derived from the drugs under scrutiny. Secondly, the authority used  a so-called ‘Cost Plus’ method, according to which the rate of profitability is measured by reference to a  Return on Sales (ROS), which was based on an industry benchmark of 13%. This analysis revealed that prices significantly exceeded the Cost Plus value (by 150% to 400%). The authority complemented this analysis by carrying out an inter-temporal price analysis and a comparison of the firm’s internal rate of return for the Cosmos products with the weighted average cost of capital (WACC).

The authority then considered that the excessive price was unfair because there were not any economic justifications for such a large increase in price. The nature of the drugs (old off-patent life-saving drugs) and of substitutes led to inelastic demand; and there were no non-cost related factors leading to an improvement in quality of the products. Instead, the business model adopted by Aspen seemed to be speculative and based on purchasing off-patent niche drugs and seeking to increase their prices.

In the UK, Pfizer sold its UK distribution rights for an anti-epileptic medicine based on phenytoin sodium to Flynn Pharma. Phenytoin is an old drug, first formulated in 1908, and is no longer recommended in most cases. The CMA reports that only about 10% of the 500,000 or so epilepsy patients in the UK take phenytoin and that demand for this drug is falling.

The system of price regulation for off-patent drugs in the UK, which is relevant to understand the anticompetitive conduct, is very complex. In this case the CMA and parties disagreed as to whether the UK authorities had the legal power effectively to control the prices of phenytoin capsules and tablets.  In brief:

  • The UK’s Pharmaceutical Price Regulation Scheme (PPRS) is a voluntary arrangement under which participating companies agree to price their products to achieve no more than an agreed maximum profit for sales to the National Health Service (NHS): a 21% return on capital employed or a 6 percent return on sales (ROS). This profit margin is for the overall returns (i.e. across all drugs) achieved by participating firms.

 

  • Suppliers which are outside the scheme are subject to “statutory regulation”. Sections 262 and 263 of the NHS Act grant the Secretary of State the power to, respectively (a) impose direct price controls on specific medicines; and (b) introduce an industry wide statutory scheme to control the price of medicines not covered by a voluntary scheme.

Pfizer has long been a member of the UK’s PPRS, which covers only branded products. By ‘genericizing’ Pfizer’s drug, Flynn exited the PPRS and thereby became able to freely price the drug – which Flynn did by increasing its price by as much as 2,000–2,200% overnight.

The CMA found that Pfizer and Flynn were dominant in the markets for, respectively, production and distribution of phenytoin sodium capsules in the UK. Such capsules had limited substitutability with other anti-epileptic drugs due to their very narrow therapeutic index (i.e. small differences in dose can lead to adverse drug reactions), which renders the switch to other products based on the same active substance dangerous for patients. As a result, clinical guidance in the UK requires ‘continuity of supply’: patients who have been stabilised on one manufacturer’s capsule should remain on that manufacturer’s capsule and not switch to another supplier.

As regards whether the price was excessive, the CMA relied on a Cost Plus method to determine the reasonable rate of return that, in turn, relied on the ROS allowed under the UK’s Pharmaceutical Price Regulation Scheme (PPRS) (equal to 6%). This was then crosschecked with the calculation by the Return on capital employed (ROCE). The comparison between the Cost Plus and the price charged by Pfizer and Flynn allowed the CMA to conclude that Pfizer’s and Flynn’s prices were in excess of Cost Plus by from around 30% to almost 700%, and from around 30% to over 130%, respectively.

This price was also considered to be unfair, because of: (1) the substantial disproportion between the applied price and the benchmark price; (2) the absence of any R&D effort or improvement in production and/or distribution or high commercial risk; (3) Flynn’s and Pfizer’s awareness of the adverse effect of the price increase on the end consumer (the NHS), witnessed also by Pfizer’s reputational concerns behind the divestiture of its anti-epileptic drug business; and (4) the fact that similar price increases were not introduced in five other EU Member States, where the product was, except in one case, sold profitably. Importantly, these elements were considered sufficient to support the finding that the price increase was unfair in itself, which rendered unnecessary to prove its unfairness through a comparison between the price of the capsules with those of other competitors’ products.

Section 4 compares the application of the legal tests deployed by these two national competition authorities (NCAs).

The authors begin by pointing out that, while the drugs in question are quite different, the cases had a number of similarities. In particular, in both cases the investment made for their development had already been recouped; both drugs were basically shielded from competition, since they could not, for different reasons, be replaced by other medicines; in both cases companies applied a business strategy that sought to maximise the revenue of old drugs that are used to treat diseases that have a low incidence in the population; and that regulation is ineffective, since regulators lost control over prices when companies ‘genericised” a drug.

An important point the authors raise is that, while these cases are in line with the restricted conditions for intervention against excessive pricing, these conditions are not uncommon in the pharmaceutical sector. Indeed, the side effects arising from changing drugs and, more generally, the inelasticity of demand to price, limit substitution between medicines. Furthermore, the non-profitability of certain product markets discourages entry, thereby stifling an effective competitive pressure.

Section 4 also compares the methodologies deployed in the UK and in Italy to determine whether a price is excessive.

The case law and practice of European institutions seems to leave the choice of which methods to deploy to assess whether a price is excessive to the authorities . The choice rather depends on the specific circumstances of the case and/or the features of the involved market. Both UK and Italian authorities seemed to favour a price-cost methodology. Comparator methods were deemed unsuitable, given that comparable products either do not exist, are not real competitors or may be excessively priced themselves.

Concerning setting the right price benchmark, two main issues seem to arise:

  • What costs should be included in the benchmark price? In Italy, Aspen’s costs were affected by the financial investment made by the company to buy the marketing rights of the Cosmos drugs. However, the Italian NCA excluded from ‘costs’ all the economic burdens that were not indispensable for the production and/or distribution of the goods, consistently with ECJ’s case law that internal inefficiencies cannot justify unfair prices.
  • What is the appropriate rate of return? This rate should be ‘reasonable’. In Pfizer, the CMA held that a rate will be reasonable when it maximises the consumers’ welfare and at the same time allows the companies’ R&D incentives to be preserved. An additional question is whether ‘social concerns’ should feed into the determination of the reasonable rate. The authors consider that both UK and Italian authorities seem to have taken such concerns into account – particularly, a concern with a right of access to medicines at reasonable price – when looking at whether there was a regulatory failure, the age of the products, the impact on R&D incentives, the stability of demand, and whether there was a regulatory profit cap. The authors praise this approach, since ‘regulation can provide an anchor that helps overcome the hardships that competition authorities might encounter in the task of proving the unfairness of a pricing policy.’

As regards unfairness, the European Commission has held that the economic value of a product may exceed the benchmark price – and still be reasonable – as a result of non-cost related factors. In line with this, the analysis by both authorities was mainly based on a thorough analysis of the (absence) non-cost related factors, instead of on a comparison with other products. In both Italy and the UK, it was the absence of non-cost related factors potentially justifying the price increase that made the significant disproportion between prices and costs unfair in itself. The authors think that the consideration of non-cost related factors requires a:  ‘a wider and thorough assessment’ of the case-specific elements, of the market context, of the regulatory framework and of the nature of the products and of the companies involved’, not unlike the analysis required for determining the appropriate rate of return.

A question this raises is whether this approach to unfairness – which focuses on price-cost methodologies – is justified. It can be argued that the ECJ’s case law requires comparative analysis in all cases, regardless of whether price-cost methodologies are applied or not. The authors consider that this ignores that price-cost tests take into account non-price factors when establishing reasonableness, which is the goal of comparative analysis. Under certain circumstances, it is argued, the price–cost test alone can provide a prima facie complete measure of the relationships existing between the price and the economic value of a product.

 

Comment:

This article provides a good overview of recent excessive pricing cases in pharma in Europe. It should be of interest to anyone who wants to understand the factual background of the cases, the methodologies deployed to identify excessive pricing, and how the two cases compare.

Personally, I have some doubts about the amount of work that the authors ask the ‘reasonableness’ of the rate of return to play. The rate of return should reflect market practice, one would assume; but, according to the authors, an assessment of its reasonableness should also incorporates other non-economic factors. Lastly, a finding that a rate of return is not reasonable is also supposed to provide evidence that the price is unfair regardless of any comparison with comparable products / situations.

This seems to provide quite a bit of leeway to competition authorities, while reducing their need to justify why the price is unlawful. In particular, it seems to make the requirement that a price be found to be unfair in addition to excessive redundant, particularly when one adopts a cost-plus method. After all, if a price is unfair because it is unreasonable, but it is also excessive because it is unreasonable, then the only question is whether the price margin to be added to the relevant measure of costs is unreasonable. It would then be up to the parties to provide evidence that the price increase is somehow justified. This would seem to run counter the two-pronged test adopted in United Brands which would place the burden of proving both excessiveness and unfairness on the authorities – and may be one of the reasons why the UK’s Court of Appeal required the CMA to conduct a comparison with other products before deciding that Flynn’s price was unfair in its decision on appeal regarding this case.

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