Competition in Off-Patent Drug Markets: Issues, Regulation and Evidence · 2013-04-22 · Competition in off-patent drug markets Kanavos, Costa-Font, Seeley 1.1. Placing emphasis

Competition in off-patent drug markets Kanavos, Costa-Font, Seeley

Competition in Off-Patent Drug Markets: Issues, Regulation and Evidence

Panos Kanavos, Joan Costa-Font, Elizabeth Seeley

LSE Health, The London School of Economics and Political Science

1. INTRODUCTION Generic medicines are proven to be chemically and therapeutically equivalent to originator brands, but are in principle significantly cheaper because they are allowed to enter the market after the patent expiry of the originator brand. In this way, generic manufacturers do not incur R&D costs and are able to offer a significant price advantage to the originator brand. As a result, health insurance is keen to promote generic use among patients as well as encourage generic competition by using a variety of policies with a view to maximising savings on the drugs bill. Given the emphasis on health care cost containment and the pursuit of efficiency in resource allocation generic policies and their perceived and actual effectiveness have been at the centre of attention for many years in the majority of OECD countries.

Policies encouraging the use of generics within health care systems have been at the centre of attention over the past decade for a number of reasons. First, as health care costs as a proportion of GDP have continued to rise in OECD countries over the past decade (Table 1), governments and health insurers have been trying to contain their rate of growth as well as improve the efficiency in the use of scarce resources (Mossialos et al, 2002). In this context, containing rising pharmaceutical expenditure, one of the most dynamic components of health spending, has been a key policy priority in most OECD countries (Kanavos and Gemmill, 2005). Yet, pharmaceutical spending as a proportion of total health care spend has continued to rise over time and per capita pharmaceutical outlays have reached or exceeded $750 in the USA, $650 in France and $500 each in Germany, Canada and Italy (Table 1). It is widely thought that generics provide a solution to overstretched health care and pharmaceutical budgets. Second, implementing of generic policies necessitates policy action both on the supply- as well as the demand-side of health care economies. Consequently, multiple actors and stakeholders are involved, incentivised or affected by such policies. Among them are physicians, who need to be convinced to prescribe generics, pharmacists, who, in order to dispense generics need an appropriate incentive structure on margins, and patients, who are at times sceptical about whether generics provide the same quality of care as originator brands. Given the multiplicity of actors and stakeholders, different policy measures and incentives need to be made available to each of these, making generic policy a complex policy area, which has, on several occasions, taken a long time to deliver low prices for off-patent drugs, high levels of penetration, and, by implication, high savings to health insurance. Third, despite the emphasis on generic policies, there is little knowledge of their actual effectiveness in different environments and whether they indeed result in sustainable price reductions and they diffuse fast and optimally in different environments.

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1.1. Placing emphasis on generic medicines Many countries, particularly in Europe and North America, have implemented

aggressive generic policies aiming to contain the cost of prescription medicines, where it appears to be easiest and where competition might enable this, namely in the off-patent sector. In France, Italy and Spain, for instance, regulators have implemented reference pricing for generics as well as generic substitution, in addition to promoting generic prescribing. In other countries, generic prescribing and dispensing have been key features of pharmaceutical policy for decades (e.g. USA and the UK). Overall, a great deal of emphasis seems to have been placed lately on the likely benefits from generic competition and generic substitution, in terms of economising precious resources to be allocated elsewhere in the health care system (e.g. to reimburse newer and effective treatments in some therapeutic areas). The argument is that generics also fulfil a socially useful role of creating headroom for innovation.

Payers in Europe and North America have embraced generic medicines through a multiplicity of policies that motivate their use. This involves, first of all, improving availability of generic medicines through regulatory interventions. For instance, Bolar provisions, a practice where generic manufacturers are allowed to complete their regulatory processes prior to the expiry of the originator molecule’s patent, are now part of regulatory policy in both Europe and North America. Second, in certain environments, the speed of making generics available on the market is rewarded by protecting the first generic by a market exclusivity; thus, in the USA, the first generic entrant post-patent expiry has a 6-month market exclusivity, which is mean t to encourage generic manufacturers enter the market fast. Third, significant attention has been paid to incentivise physicians to prescribe generically and pharmacies to dispense generically. To that end, generic prescribing has become compulsory in many EU countries and is viewed as a means to achieve (significant) savings to health care (and drug) budgets. Other incentives (e.g. budgets) may be in place, explicitly providing an incentive to prescribe generically, whenever possible. Generic substitution is now widely practiced and has been one of the pillars of government drug policy in the majority of EU countries over the past 7 years. Finally, there is an increased movement towards unbranded generics, for example in Germany, over the past decade.

At the other end of the spectrum, generic policies may be characterised either by policy inconsistencies or bottlenecks, or, indeed trends, which may lead to generic policies becoming ineffective in terms of delivering either sufficient savings to payers/consumers, or, indeed, providing the competitive environment needed for the headroom for innovation to be realised. Such policies or trends include, among others,fixed reimbursement through reference pricing (Canada, Germany, France, Italy, Spain), and, second, maximum allowable prices for generics, for instance generic product prices will be at most at 70-80% of brand product price (France, Italy, Spain); by linking generic prices to those of branded products, the former are overpriced because of their low(er) overall production costs. If “high” generic prices are supported by health insurance regulation, a key policy question then is whether this regulation yields benefits to health insurers and, if not, to whom; in other words, which stakeholders benefit from this practice, by how much and whether consumers/patients are better off.

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The use of generic medicines has been seen in many countries as a partial remedy to address the problem of ever increasing expenditure on pharmaceuticals and optimally re-allocate resources so that innovation can be rewarded at a premium, whilst commodities, such as generic medicines, be subject to price competition. Given their cost advantage over originator brands and the incentives provided to facilitate fast entry and diffusion, generics should offer significant savings to health insurance. Yet, the variability with which generic medicines diffuse in different countries and the complexity of generic policies pose a series of questions, which still remain unaccounted for: first, what are the determinants of generic penetration and the type of product characteristics that are likely to influence it? Second, what is the impact of generic entry and penetration on drug prices, having controlled for individual product characteristics? Third, are generic prices influenced downwards by the entry of new competitors and are prices of branded products sensitive to competition from generics? By how much do prices of generic medicines decline over time and what are the factors that determine price reduction? And, finally, what is the impact of (pricing and reimbursement) regulation, market structure and product differentiation on generic competition and generic drug prices?

1.2. Organisation of the paper In this paper we use proprietary data on a selection of off-patent medicines from

Intercontinental Medical Statistics (IMS) from 7 of the largest pharmaceutical markets globally, to analyse the competition patterns in their off-patent (generic) sector. We develop a panel data model that allows us to explain the overall determinants of generic prices post patent expiry, the determinants of generic diffusion, and the relationship between originator branded and generic prices. The structure of the data allows us to explore these endpoints both at aggregate and at the highest level of disaggregation, namely, the product presentation level. Section 2 summarizes the findings of the literature on generic medicines and competition. Section 3 discusses how generic policies work in practice in the study countries and analyses the impact of generic policies on price, volume (diffusion) and the individual stakeholders. By developing a panel data model, section 4 examines the determinants of generic competition and generic diffusion at aggregate and product presentation levels; it also investigates the relationship between originator brand and generic price, following the introduction of the latter. Section 5 briefly discusses the results and the policy implications that arise. Finally, Section 6 draws the main conclusions.

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2. LITERATURE AND CONCEPTUAL FRAMEWORK Generic medicines are thought to compete on price with the originator brand but it

does not automatically follow that lower drug prices due to generic penetration will result in a high level of generic uptake (Mrazek and Frank, 2004; King and Kanavos, 2002). Whether generic entry leads to a reduction in the market share of the originator product depends on factors that may encourage or discourage generic uptake besides the perceived price competitiveness of generics. Indeed, market penetration of generics also depends on the institutional arrangements of drug regulation and the nature of drug policies in place (Grabowski and Vernon, 2002; CBO, 1998). The extent to which these policies affect generic uptake from a supply-side or a demand-side perspective matter. For instance, supply-side policies may affect prices of branded or generic products or both. Policies that regulate the price of in-patent products may hinder the extent to which generics are price competitive. Conversely, where in-patent products are priced freely at launch may offer generics a greater chance of gaining market share with an aggressive pricing approach.

However, even if generics are price competitive, consumers may have loyalty to the originator brand or to another in-patent product. Hence, demand side policies are also important. For instance, much depends on whether insurance covers all or a share of consumers’ pharmaceutical costs, or the extent to which they are subjected to differential co-payments depending on the drug chosen. Moreover, policies focusing on physician prescribing (e.g. managing a pharmaceutical budget or INN prescribing) and pharmacists (e.g regressive retail margins combined with generic substitution) to encourage and promote generics play an important role (Walley and Mossialos, 2004; Chaix-Couturier, Durand-Zaleski, Jolly et al., 2000; Delnoij and Brenner, 2000; Harris and Scrivener, 1996; Schoffski, 1996), provided that such policies are adequately enforced by health insurance (Baldwin, 1997). That is, the incentive structure for physicians, pharmacists and consumers will interact with supply-side policies on pricing. It is this interaction that will lead to either a net effect of encouraging or discouraging generic uptake relative to the originator product or other in-patent products.

2.1. Generic entry, competition, diffusion and brand loyalty Empirical evidence has found that even though residual loyalty remains after

patent expiry, it does not completely deter generic competition (Mrazek and Frank, 2004). Within one year of entry, generic products capture a large share of prescriptions dispensed (44%) and market sales (50%) in the USA (CBO, 1998; Grabowski and Vernon, 1992). Evidence on generic prices indicates that they fall to a small fraction of the originator drug price, although this evidence comes from the US setting, where significant price competition exists and price regulation is absent; by contrast, similar evidence from a European setting is not available. At the time of generic launch, the average generic price was 25 percent lower than the originator price and as more generics entered the market, the price fell to about one-fifth of the initial average generic price in the US (OTA, 1993).

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While there seems to be ample evidence, particularly from the US, on the downward course of generic prices post patent expiry, the relationship between originator brand and generic price has been subject to a fair amount of debate in the literature. Limit pricing theory would suggest that it may not be in the incumbent firm’s best interest to raise prices when faced with the prospect of entry and competition (Bain, 1949). Yet, in the case of pharmaceuticals, where originator brands lose their monopoly position after patent expiry, brand-name manufacturers do not necessarily compete on price once generic competitors enter the market, despite generic prices being lower than the originator price. As a result, originator brand prices may increase rather than decline post-patent expiry (Grabowski and Vernon, 1992; Grabowski and Vernon, 1989; Frank and Salkever, 1997; CBO, 1998). This is the so-called “generics paradox” which predicts that a higher penetration of generic drugs would not necessarily lead to a reduction in originator drug prices; instead, originator drug prices may rise (Grabowski and Vernon, 1989). Further evidence has shown that generic entry does not necessarily lead to a reduction in originator (branded) product prices (Lexchin, 2004) and may only slow down the increase in these prices (Caves, Whinston and Hurwitz, 1991). Suh (1999) find evidence supporting the generics paradox by comparing the total market price index with the price index of products whose patents expired. In particular, the price index for the total market increased annually at an average rate of 7.9% during the patent protection period but declined by an average rate of 6.8% each year afterwards. For originators, the Fisher price index annually increased by 9.1% before patent expiration and by 6.0% afterwards. Ellison and Ellison (2000), nevertheless, using a price index find that prices tend to increase in the last year of patent expiration. More recent evidence, however, does find some competitive effects from the originator product in the presence of reimbursement regulation, such as reference pricing, and the fear of complete loss of market share (Rizzo and Zeckhouser, 2005; Kanavos and Srivastava, 2007), but applies only to a very limited number of products. One of the potential reasons for the generics paradox may well rest with the supply-side. Indeed, it may be profitable for large global firms to focus only on fewer, but price sensitive consumers (Wang, 2006). Finally, whereas the above stream of literature has examined overall competition in off-patent markets particularly examining the behaviour of brand and generic products post patent expiry, there is no research conducted into the patterns of competition among generic firms post generic entry.

2.2. Generic penetration, regulation and barriers to entry

The theoretical discussion has concluded that there may be a limitation in generic penetration which may, in turn, hinder the benefits from generic competition. In fact, there may be barriers to entry in generic markets, resulting from (a) regulatory or discounting practices (Kanavos, 2007), (b) strategic pricing by first entrants, implying that there may be first mover advantages in the market for generics (Hollis, 2002), or (c) an interaction between stakeholders, such as providers, physicians and pharmacists and their incentive structures. There is, however, limited empirical evidence on competition patterns within generic markets, the impact of regulation and the extent to which countries differ in their price sensitivity to drugs. Overall, drugs markets are subject to significant imperfection both from the demand and especially form the regulatory

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intervention (supply side) which justify the existence of marked differences with other markets. On way to examine this issue further is by examining the influence of competition in different markets. Price regulation affecting the generic market may have an adverse effect on generic price reduction over time. The impact of regulation on generic drug prices has led to opposite conclusions. Some studies have found that countries with strict price regulation (e.g. France, Italy, Spain) have lower prices than countries with less strict regulation (e.g. Germany, Sweden, UK) (Jonsson, 1994; Garattini 1994; Rovira, 2001). Others have concluded that competition has kept prices low in markets with less regulation such as Germany, and the UK (Reekie 1998; Danzon and Chao, 2000). Evidence form Canada shows that the efficiency of generic competition in reducing drug prices was very moderate or inexistent (Jones et al, 2001). Danzon and Chao (2000) found that generic penetration is more common in unregulated markets such as the US, UK, Canada and Germany as compared to France and Italy. However, this would depend entirely on the incentives of several stakeholders that can influence the distribution of rents arising from generic competition. The effect of regulation includes a “ratchet effect” (Bergman and Rudholm, 2003) resulting from the fact that given that prices signal low marginal costs, a low price would be difficult to increase. Some studies distinguish actual form potential competition, and find significant and comparable effects of potential to that of actual competition (Bergman and Rudholm, 2003; Cool et al, 1999), despite potential competition being affected by regulation and barriers to entry.

2.3. Acceptance of generics by patients

Marketing strategies by pharmaceutical companies also affect consumers’ attitude toward generic drugs, Consumers who are the ultimate users of medications have the right to accept or decline generic substitution. Evidence on consumer acceptance suggests that education programs to foster generic uptake seems to be showing its effects. Consumers in the USA were more favorable regarding generic drug substitution if they had a favorable attitude toward generic drugs. However, a few consumers still believe that generic drug substitution may result in less effective medications and may compromise the quality of the medications they take (Sansgiry and Bhosle, 2006). However, in European countries there is evidence pointing that generic drug substitution for a number of patients is not considered an equal alternative to branded drugs, and these patients may need additional information and support (Kjoenniksen et al, 2006).

In two separate studies conducted in the mid-1990s, pharmacists reported that 25% to 38% of patients ask that generic products be used and estimated that 12% to 15% refuse generic medications. The general acceptance of generic medications by most patients, including the substantial minority who actually request them, has perhaps helped shape the generally positive beliefs pharmacists have about generic drugs (Cage, 2001). Generic substitution is also influenced by patient related factors such as price sensitivity, the differences in co-payment between brand name and generics, and the availability of low cost generics.

2.4. Lessons from the literature and conceptual observations

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Overall, it is difficult to draw general conclusions from the empirical literature because of methodological differences in the range of products considered, the extent to which generics were included or not, the time series nature of the data, and the method of calculating price indices (Danzon, 1998; Kanavos and Mossialos, 1999). Such differences make it difficult to identify causal effects because of the many factors that influence drug prices: differences in health system structure and financing, pharmaceutical subsidies, cost-containment policies, product mix and production costs (Productivity Commission, 2001). Despite their methodological and other limitations, the results from the empirical research have shown that, first, market shares of the originator brand fall after generic entry, but prices may actually rise; second, prices of generic products fall to a small fraction of the originator drug price, but the extent of that may be dependent on regulation; third, price regulation affecting the generic market may have an adverse effect on generic price reduction over time; fourth, within the context of studying competition in off-patent markets, the pattern of competition among generics in individual settings has not been studied. Similarly, the effects of product differentiation within generic markets have not been studied, therefore, phenomena pertaining to the wide consumption of “branded” generics1, the determinants of their use as well as the factors that influence entry and exit remain unexplained.

From a conceptual perspective, in countries where generics are not subject to price regulation products typically seem to follow a competition game that resembles a Betrand model. Yet, depending on the existence of any form of product differentiation2 generic manufacturers typically enter sequentially in waves over time. Branded generics are likely to enter fast soon after patent expiry, capture a significant part of the entire market at a price premium. As competition intensifies, additional generic firms enter the market. (Price) competition may lead to exit by some players from the product market altogether or some components of it3. Accordingly, one would expect to find entry of 1 Branded, as distinct from unbranded generics are generics whose manufacturers launch them with a particular brand name, which can be a “fantasy” or invented name (protected by trademark law), or the name of the manufacturer followed by the name of the molecule (e.g. Ratiopharm-Simvastatin). In this way, generic manufacturers aim to establish themselves in a particular product market by creating brand awareness, and, potentially, brand loyalty among prescribers and/or patients. Brand loyalty may be associated with the effect of perceived quality among consumers, but is in no way related to the actual efficacy of the generic product, since both branded and unbranded generics need to prove themselves to be bio-equivalent to the originator molecule. Germany is par excellence a branded generics market. Branded generics are distinct from unbranded generics where the brand awareness is not present. When receiving an unbranded generic medicine, consumers are not aware of its source, without meaning that absence of an identifiable source is in any way related to poor efficacy. An example of a mainly unbranded generics market is the United Kingdom. 2 Differentiation can take a variety of forms in generic markets. It can be related to (a) the actual brand (branded versus unbranded generic) and the loyalty it may command among prescribers and/or patients, (b) different dosage, (c) different pack size, and (d) whether the generic firm offers all or part of the product dosage and pack sizes, among others. There is little other product differentiation occurring at this point, since all generics containing the same molecule are bio-equivalent to the originator molecule, and, therefore, they have, in principle, similar side effect profiles. 3 The product market is defined by its sub-market components; these are influenced heavily by dosage and pack size. For instance, the market for simvastatin is divided into the market for 10mg, 20mg, 40mg and 80mg. Often, the type of patient that requires 10mg is different from the type of patient that requires 20mg or higher dosage. As a result, product markets are, most frequently, segmented. There are, of course, other dimensions that may matter, such as whether the product can be available as injectable, or in suppository

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new generic competitors that attempt to capture market share whilst the originator often remains with a small market share of the brand loyal market or simply exits in some cases. However, when pharmaceutical markets are regulated then genric firms have incentives to maximise their market shares in the presence of regulation, or use the existing regulatory measures, such as reference pricing4, to their advantage, to maximise market shares and rents (Aronson et al , 2001). This may imply lobbying, intense product discounting practices and tacit collusion so that prices become rigid downwards once a reference price has been established.

form, as a pill, capsule or tablet. Evidence shows that some patients may prefer or need injectable delivery, others stay with oral delivery or in suppository form. 4 Reference pricing is a form of reimbursement regulation, whereby health insurance sets a maximum reimbursement price per product (or per product class), irrespective of the price variation that exists on the market. This means that nothing above the reference price will be reimbursed and patients will bear the additional cost out-of-pocket.

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3. GENERIC MEDICINES IN EUROPE AND NORTH AMERICA: POLICIES, STYLISED FACTS AND IMPACT ON HEALTH CARE BUDGETS

3.1. Generic policies in OECD countries: Stylised facts 3.1.1. Supply- and demand-side policies. The explicit policy assumption behind the use of

generic medicines is that they can generate significant savings to health insurance because of their lower cost compared with branded originator medicines. Payers in Europe and North America have embraced generic medicines through a multiplicity of supply- and demand-side policies that motivate their use to bring about these savings (NERA, 1998; Kanavos, 1999). Supply-side measures relate to market entry and penetration of generic medicines, as well as issues around pharmaceutical pricing, setting a reimbursement price acceptable to health insurance funds and determining the number of pharmaceutical products available in a reimbursement (positive) list. Policies impacting on the demand for generic medicines may be imposed to elicit a response from prescribing physicians, dispensing pharmacists and/or purchasing by patients. Traditionally, incentives have been directed at physicians though, increasingly, pharmacists are the target of financial incentives (Garattini and Tediosi, 2000). The way to influence patients is through a system of cost-sharing that favours generic medicines. This may or may not work, depending on other parameters of the health care system, such as overall price levels for medicines and insurance coverage. It is difficult, however, to quantify the savings for the health care system attributable to any one of these broad categories, let alone a single policy measure. No country has introduced policies and followed their impact without making further changes to their health system, but some research evidence has been produced that attempts to estimate the savings of specific policies (NERA, 1998; Simoens, 2006). While recognising that these estimates are subject to other influences, these policies can be identified as having some effect as they appear across countries with strong generic markets.

3.1.2. Regulation regarding marketing authorization. Regulatory approval to market a generic medicine has a direct impact on competition within the pharmaceutical market. Competition is impacted by both the timing of generic approval applications and the length of time for processing such applications. Current legislation in the European Union does not allow preparatory work such as bioequivalence studies and the submission of samples necessary to register a generic product before patent expiry (EGA, 2002), although several Eastern European countries do have such a provision. In Canada and the US, activities required to secure regulatory authorisation to market a generic drug can take place, and applications for approval submitted, prior to patent expiry (CDMA, 1999). This provision, otherwise known as a Bolar amendment, allows generic firms to compete in the post-patent market almost immediately following patent expiry. This should in theory result in some price competition and lower prices for the substance in question, although the extent of price competition would depend on whether the duopoly that exists at the time of first generic entry (brand manufacturer and first generic entrant) seizes to exist as further generic firms enter the market after the expiry of the first generic’s market exclusivity period. Nevertheless, without a Bolar amendment in place, branded originator manufacturers are effectively granted an extension of their patent term

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for the length of time it takes for bioequivalence testing to be undertaken, thus eliminating savings that could accrue during this period.

Drug application approval times are also significant. In the US, the 1984 Hatch-Waxman Act introduced the Food and Drug Administration's (FDA) Abbreviated New Drug Application (ANDA) scheme to attempt to decrease the time required for approval, thus allowing the savings attributable to generic drugs to commence sooner. Under the ANDA, a generic drug seeking marketing approval must have the same active ingredient(s) as the innovator product; must use the same route of administration; must have a similar rate and extent of absorption of the active ingredient; and must be produced in facilities that meet good manufacturing process guidelines. Generic manufacturers are not required, however, to include pre-clinical and clinical data to establish safety and effectiveness. As a result of the abbreviated application, the generic drug approval process in the US decreased to approximately 18 months in 1998 (CDER, 1998). Despite the ANDA process, however, the length of approval times for generic drugs exceeds that of new drugs. For the fiscal year 2000, the FDA approval time for a new drug was, on average, 11.6 months while the average generic drug approval had risen to 22.3 months (CNNfn, 2001). A potential cause of the increase in generic drug approval times may be patent-holders prolonging court battles against proposed generic drugs. In Canada, reviews of marketing approval applications are conducted at the federal level of government, but each province independently decides whether a new generic drug should be included in their drug plans. This process varies widely across provinces. Thus the system does not achieve an optimally efficient allocation of resources due to the duplication of effort taking place at the provincial level.

3.1.3. Pricing of generic medicines. Countries with well-established generic pharmaceutical

markets may or may not impose regulation on pharmaceutical prices. The US and Germany do not impose price ceilings on new pharmaceutical products, although Germany has a reference price system in place for patent-expired substances. France, Canada, the Netherlands, Denmark and Italy, do have various regulatory arrangements in place controlling the prices of new medicines and, in France and Italy, the prices of generics. In the UK, the price of a new pharmaceutical product is indirectly regulated as the pharmaceutical price regulation scheme (PPRS) stipulates the rate of return on capital employed in sales to the NHS (Mrazek and Mossialos, 2000). Manufacturers have flexibility, however, on how they price each of their products. It is possible for the branded manufacturer to significantly reduce prices of their older products to allow them to fit under the profit threshold while setting a high price on their newer products (Mossialos, 1997). Despite the relative freedom in pharmaceutical pricing, the UK has introduced price controls on generic products to counteract adverse supply problems that occurred at the end of 1990s, and were partly related to the quality of produced generics (DH, 2000).

There are additional elements that affect the nature and extent of price competition in a patent-expired market, including the number of entrants and the nature and extent of (price) regulation. The number of manufacturers can greatly influence the degree of price competition, forcing prices even lower. If only a few generic manufacturers market a particular product, there is less price competition and a greater

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chance of (tacit) collusion on price. As the number of competing manufacturers increases, the greater the competition on price among firms. Two studies conducted in the US confirm the inverse relationship between the price of a generic drug and the number of competing firms (CBO, 1998; Caves, Whinston and Hurwitz, 1991).

Direct price controls are a common phenomenon, even in generic markets and several examples are in place to demonstrate this. Countries such as France, stipulate that prices of generics should be 30% lower than the equivalent branded product (Kanavos, 2002). In Canada, under the terms of a 1998 agreement between the Canadian Drug Manufacturers Association and the Ontario government, new generic drugs came onto the Ontario Drug Formulary at a maximum of 70% of the price of the originator drug. The second and subsequent products will be added at a maximum 63 per cent of the original cost (down from 65%). In return for accepting lower prices, the generic industry would receive more secure access to the Ontario marketplace through regular Formulary updates (CDMA, 1999).

In the UK, a statutory maximum price scheme has been introduced for some generic medicines to counter speculation in the generic drug supply chain (Mrazek and Mossialos, 2000). This covers a number of commonly prescribed generic drugs in primary care. However, even subsequent to the introduction of the maximum price scheme, many reimbursement prices are significantly above real market prices as the maximum price does not account for competition between major wholesalers on price (DH, 2001). As a result, the NHS may not benefit from the full savings that result from competition between wholesalers. An investigation into the extent of discounting offered by wholesalers to pharmacists in the Netherlands led to the introduction of a claw-back applied to the maximum reimbursement price that pharmacists receive (OXERA, 2001).

3.1.4. Reimbursement ceilings and emphasis on Reference Pricing. To promote the use of generic medicines, one approach is to regulate reimbursement of pharmaceuticals, as opposed to regulating launch prices. One such option is reference pricing, which involves grouping together similar products and defining a relative price that will be reimbursed by health insurance funds. Thus, if a pharmaceutical product is priced above the reference price, the insuree is required to pay the difference in price (Giuliani et al, 1998). The degree to which reference pricing encourages generic medicines is dependent on how this policy tool is implemented.

Policy makers wishing to implement reference pricing as a reimbursement mechanism for pharmaceuticals are faced with three main policy choices (Kanavos, 1999). Firstly, it needs to be decided how the clustering of similar medicines is going to take place. One option is to group medicines with identical active ingredients. Another option is for medicines with therapeutically comparable active ingredients to be grouped together. And the third option is for medicines with therapeutically comparable effects (rather than active ingredients) to be grouped together. This latter grouping includes potentially a wide class of medicines that are all effective for the treatment of a given condition.

The second decision that policy makers need to take is to decide whether patented medicines are to be included in the defined clusters. If patented drugs are not included in the groupings, there is much lower impact of reference pricing on increasing generic prescribing

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and reducing overall spending (Mossialos and Legrand, 1999). As long as patients receive reimbursement for newer, patented products, these are the medicines they are likely to choose, and savings will accrue only in choices between generic products. The third policy-related issue relates to the fixing of the reference price. For example, the reimbursement price may be set at the lowest priced drug in the defined cluster (Hensley, 1999) or may be based on the average price within the cluster (Lopez-Casasnovas and Puig-Junoy, 2000).

It is important to note that where originator and generic pharmaceuticals are both included in drug groupings and the price is set at the (average) generic price, the degree to which reference pricing will encourage the use of the generic drug will depend upon the response of the manufacturer of the originator drug. If the price of the originator drug is not lowered from its original price, reference pricing offers a strong incentive for preference of the generic drug (Giuliani et al, 1998). If, however, the price of the originator drug is lowered to approach the reference price, this incentive is reduced. If the focus is on savings in pharmaceutical spending, as opposed to more strictly encouraging generics, the lower originator price will have a positive effect.

Consideration must also be made of the effect of the degree of market competition in the market at the time the reference price is set. As previously noted, generic drug prices decrease substantially as more manufacturers enter the market. If the reference price is set at a point where few manufacturers are competing on price it may have the effect of removing the incentive for further price competition to take place. In Sweden, the response to the introduction of reference pricing in 1993 was the lowering of prices to the reference price, or below, by most producers. Thus while Sweden still has a relatively low generic penetration, reference pricing is credited for modest savings (Ljungkvist et al, 1997).

In Germany, the prices of drugs including in reference pricing groups declined, but branded drug manufacturers compensated for this by increasing the price of non-reference-priced drugs (Giuliani et al, 1998). Because both wholesalers and pharmacists receive a fixed margin regulated by the government, there is no incentive for discounting below the fixed limits. For German Sickness Funds, the savings brought about by reference pricing are estimated to be DM 3 billion per year (Busse, 2001). This equates to 9% of pharmaceutical expenditure.

The Canadian province of British Columbia introduced a reference-based system in 1994 in its programmes for seniors. It was later applied to social assistance recipients and members of households with high drug costs (though the latter group pay a deductible). The system includes in-patent products and clusters medicines that have therapeutically comparable effects. Grootendorst et al estimate savings of CDN$ 14.9 million to British Columbia's (BC) Pharmacare expenditure on nitrates prescribed to the over age 65 BC population during the three and a half years after reference pricing was introduced (Grootendorst et al, 2001). The authors note, however, that the effect of reference pricing needs also to be evaluated in its effect on associated health care and administrative costs.

3.1.5. Policies directed at physicians. Physicians are responsible for generating demand for medicines through prescribing. As a result, influencing the way physicians prescribe can significantly affect generic prescribing. This can be achieved by providing physicians with

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financial or/and non-financial incentives. Financial incentives include physician budgets. Physician fixed budgets provide an explicit incentive to contain costs, which, in turn, encourages generic prescribing, among other things. The incentives may be structured to reward physicians who underspend, or penalise those that overspend, or both. The international experience suggests that unless budgets are fixed and linked to clear and enforceable rules, they will not work. Two key examples are available in this respect, one from the UK (partial success) and one from Germany (complete failure)

In the UK, General Practitioners (GPs) were allocated a budget between 1991 and 1999, in a policy known as fundholding. Any savings that fundholders made could be reinvested in the practice. Evidence suggests that fundholders were more cost-effective prescribers and could save more on their drug budgets by prescribing, among others, more generics. Indeed, while GP fundholding was in place, it led to (modest) increases in generic prescribing (Whynes et al, 1997; Wilson et al, 1995). Also the effect of using financial incentives to change generic prescribing behaviour of non-fundholding GPs was studied and it was found that the incentives increased generic prescribing and resulted in the achievement of target savings (Bateman et al, 1996), albeit modest. One potential confounder, however, is the fact that fundholding GPs were partly inhibited by the threat of having their future budgets reduced. Although fundholding ceased to exist in 1999, the current follow-up on fundholding is practice-based commissioning which enables physicians to purchase services directly on behalf of their patients (DH, 2006) aiming at the same time at cost effective prescribing.

Budgets for physicians have also been present for a long time in Germany, up until they were formally abolished in 2001 – 2002, to be replaced with indicative budgets in 2003. There, financial penalties were in operation for prescriptions exceeding the budget for pharmaceuticals. The 1993 Public Health Reform Law set a global GP pharmaceutical budget of US$ 15 billion (Himmel et al, 1997). The amount spent above this limit would be paid from physicians’ remuneration budgets. After the introduction of this policy, surveys showed that in West Germany, 55% of doctors responded by increasing their prescribing of generic medicines (Muller, 1994). A unwanted side-effect of the policy, however, was an increase in the in number of patients admitted to hospitals, to save on GP's budgets (DKG, 1993). The problem with budgets in Germany was that the penalties envisaged in the legislation were never enforced. As a result, adherence to the limits imposed was poor and budgets were eventually abolished only to be reintroduced in 1998 and to be re-abolished in 2001 -2002 once again. One important policy conclusion, therefore, relates to enforcement of the actual legislation. In this particular case, failure to enforce it led to its eventual abolition.

3.1.6. Pharmacy reimbursement policy and generic substitution. For policies encouraging the use of generics to be successful, it is important that pharmacists (a) are reimbursed in such a way as to not discourage them from dispensing the least expensive product and (b) are able to substitute for a cheaper generic if a physician has prescribed a branded medicine, so long as a generic is available. Pharmacists may also be receiving discounts and rebates from wholesalers and/or manufacturers. Discounts typically provide incentives for pharmacists to dispense one drug versus another. Discounts are,

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nevertheless, outside the scope of public policy, unless they are disallowed. This would leave only the regulation of margins to influence pharmacists’ dispensing practices.

The European experience, where pharmacy margins are regulated, suggests that pharmacists are typically remunerated by health insurance organisations by means of fixed fees per prescription, progressive (percentage) margins or regressive margins. Flat fees per prescription or fixed percentage margins do not provide an incentive for pharmacists to dispense generic medicines. Under a fixed fee per prescription, the pharmacist receives the same reimbursement for dispensing an original drug as for a generic drug. In countries where pharmacists are reimbursed based on a fixed percentage of the drug’s retail price, there is a disincentive to dispense generics (Garattini and Salvioni, 1996), as pharmacists receive more in monetary terms for dispensing a branded product, than for dispensing a generic, given the latter’s lower retail price. A regressive margin that pays pharmacists a greater percentage of the cost on lower priced pharmaceutical products removes this disincentive, provided that the structure of the regressive margins is such that ensures profitability for generic dispensing. Most EU member states currently remunerate pharmacists on the basis of regressive margins and view that as an opportunity to influence generic dispensing positively (Kanavos, 2001). In most Canadian provinces, pharmacists have an incentive to dispense generics as they are reimbursed by the provincial drug plans for only the cost of the generic drug equivalent, if one exists. Similar arrangements hold in the USA for federal or state pharmaceutical assistance programmes, such as payment of pharmaceutical benefits of veterans by the Department of Veterans Affairs (Blumenthal and Herdman, 2000) and Medicaid (Kanavos, 2002) respectively. The majority of pharmacy remuneration in the USA, however, is based on reimbursement limits (DHHS, 2000). Pharmacists can, therefore, increase their margins by negotiating discounts from suppliers and there is no (federal or state) government or insurance intervention on margin determination. Another potential financial incentive for pharmacists is to allow them to keep some or part of the discounts that accrue from dispensing cheaper products. Examples of a system that rewards cost conscious dispensing can be found in the UK and the Netherlands, where part of the pharmacies’ income is achieved through discounts. IN the Netherlands, through the Drug Reimbursement Scheme of 1991, pharmacists are allowed to keep one-third of the savings made via the use of less costly generic alternative (Garattini and Tediosi, 2000). Another option is to establish negotiated income targets for pharmacists.

An effective policy on margins or incentives regarding discounting would be incomplete without generic substitution. Through generic substitution a pharmacist is authorised to dispense the generic version of a medicine even when a GP has prescribed it by brand name. There are various levels of generic substitution. Pharmacists may have wide substitution rights, in other words they can substitute freely for a generic, but their rights may also be limited, which may mean that they need to obtain authorisation to dispense a generic or be allowed to dispense a generic in emergencies only. Generic substitution is potentially a significant policy tool in increasing the market share of generic medicines and is allowed in some form in Canada, Denmark, Germany, the Netherlands and the US (Garattini and Tediosi, 2000; Anis, 1994; Banahan and Kolassa, 1997; Huttin, 1996). Typically the physician is given some control to prevent substitution where a particular situation warrants this. Generic substitution rights and pharmacy

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reimbursement incentives through regressive margins are two different facets of the same policy that would promote generic use more widely.

Patients usually respond positively in generic substitution, especially when they are presented with the option to purchase, and contribute towards the cost of, a more expensive branded product by means of a higher (tiered) co-payment. A UK study found evidence that patients do not object to being changed from originator to generic medicines (Young, 1994). Of 1,917 patients who had their original prescriptions changed from a originator to a generic drug, 90.5% were still taking the generic drug six months later. The introduction of generic substitution complicates the establishment of liability for adverse drug reactions. With generic substitution, the doctor transfers some of his or her professional authority to the pharmacist, and with it the blame for prescribing a cheaper drug if anything goes wrong. Evidence of the benefits associated with generic substitution can be observed in the Health Maintenance Organisations experience in US. The expansion of managed care, and the constant pressure to contain health care costs, has led hospital pharmacies to increasing rely on generic substitution (Sloan et al, 1997). In the US, generic substitution rates have increased from 63% of prescriptions in 1990 to 71% in 1996 (Strollo, 1999).

3.1.7. Measures targeting patients/consumers. Patients may also have a say in the case of

substitutable medicines. One such way is through the structure of the co-payment system and another is through the reference pricing system. Typically, co-payments are flat fees per prescription, percentage of the prescription cost or deductibles. A flat fee would not, in principle, promote generic use, unless there is a tiered flat co-payment structure in place, in other words, patients would pay less for a generic and more for a branded drug. This system prevails in the US, where HMOs and indemnity insurance companies view tiered co-payments as a means to leave consumers with the final choice of drug selection. The percentage co-payment can also promote generic use, as, ceteris paribus, consumers pay a proportion of the cost of the drug dispensed. Reference pricing also leaves the choice of final drug selection with the consumer, since, typically, it reimburses a cheaper generic. Patients who wish to purchase the more expensive branded will have to cover the difference between the reimbursable drug and their drug of choice. This arrangement works well in reference pricing systems that include identical drugs only, whereas it becomes more complicated when interchangeable or therapeutically similar drugs are included in a given cluster.

3.1.8. Information systems. Information systems can play a significant role both at prescribing and dispensing levels. An electronic prescribing database can serve as a quick, simple, guide to effective prescribing, and can facilitate accurate, up-to-date knowledge of generic medicines. An international comparative analysis identified two countries, the Netherlands and Australia, where an increase in demand for generics resulted from the introduction of electronic databases supplying doctors with comparative information on price and substitutability between pharmaceutical products (NERA, 1998). In the UK, when a doctor enters a brand name medicine name into the computerised prescription writing system, it automatically fills in the generic name. The

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impact of such a policy is also likely to be dependent on the financial responsibility of the doctors. Without financial incentives, it may be less likely that physicians will access such price comparative data to their patient's benefit.

3.1.9. Summary of policy tools used to increase the use of generics. The policies described above are often used in combination to facilitate a high prevalence of generic pharmaceuticals. Table 2 illustrates this. It can be seen that systems that either facilitate early market entry of generic pharmaceuticals or put in place financial incentives for their use, are best able to achieve the dual aims of increasing the consumption of generic drugs and creating a competitive market in which substantial differences in prices exist between the generic and branded, originator versions of a pharmaceutical product. In Germany, the presence of financial incentives for physicians and pharmacists are offset by fixed reimbursement limits that remove the incentive for generic drug manufacturers to compete on price.

A policy of allowing generic substitution is prevalent in the selected countries. However, generic substitution, although desirable, is not a necessary and sufficient condition for high generic use. For instance, the UK is unique in achieving a high level of generic drug use despite not employing a policy of generic substitution. The UK policy of using generic drug names in medical education programmes is credited with setting in place a prescribing behaviour over the career of the physician with substantial impact on increasing generic prescribing. This policy is also in place in Canada. In the UK, more prescriptions are, in fact, written for the generic version of a medicine than are dispensed generically. The high level of generic prescribing in the UK illustrates that other policy tools, particularly at prescribing level, are effective and warrant consideration by policy makers wishing to increase the use of generic medicines.

3.2. Impact of generic policies on health care budgets and stakeholders Despite the proliferation of generic policies in many countries, particularly in

Europe, little is known about the effect these policies are having on macroeconomic or microeconomic efficiency, i.e. the extent to which they help contain the rate of growth in pharmaceutical costs, and the extent to which they help improve resource allocation by creating “headroom for innovation”. Evaluation of generic policies has been scarce and has focused on individual aspects of generic policy, such a reference pricing, often from an ad hoc perspective, and most frequently without due consideration of the dynamic implications of its introduction, but focusing almost exclusively on the static benefits accruing to health insurance (Giuliani et al, 1998; Grootendorst, 2001). In addition, in an environment characterised by commodities, where (price) competition should flourish, there is little explanation as to why individual countries (France, Spain, Italy, among them) continue to place upward ceilings on the prices of generic products as well as a reimbursement ceiling through reference pricing. This behaviour, irrational though it may seem, appears to be to the satisfaction of decision-makers, who, in turn are satisfied to see some financial benefits arising from generic purchasing, but because of regulation, they may not be in a position to see these benefits being maximised.

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3.2.1. Data sources. In order to measure the impact of generic entry on stakeholders, we used data from the Intercontinental Medical Statistics (IMS) database and focused on thirteen molecules, selected across a wide range of therapeutic categories. The molecules selected were: amoxicillin (moderate spectrum antibiotic), clavulanic acid (beta lactamase inhibitor, broad spectrum antibiotic), hydrochlorothiazide (calcium-channel blocker; anti-hypertensive), iron ferrous (iron deficiency, anemia), levonorgestrel (oral contraceptive), lisinopril (ACE I inhibitor; anti-hypertensive), mesalazine (aminosalicylate, anti-inflammatory), methylphenidate (amphetamine-like prescription stimulant; attention deficit & hyperactivity disorder), metformin (anti-hyperglyceamic, oral anti-diabetic), omeprazole (proton pump inhibitor, peptic ulcer), paroxetine (SSRI, anti-depressant), salbutamol (beta agonist, asthma and chronic obstructive pulmonary disease), and simvastatin (statin; dislipidemia and primary & secondary prevention of coronary heart disease).

The analysis covers the retail pharmaceutical markets in the United Kingdom, Germany, France, Italy, Spain, United States, and Canada. The rationale behind the selection of these countries lies in that they rank in the top eight pharmaceutical markets worldwide by value. They also represent a good balance between countries with long tradition in using generics (USA, UK, Germany, Canada) and countries that have only in recent years adopted aggressive generic policies (France, Italy, Spain). Finally, the country selection reflects the wide range of regulatory measures whether on the supply- or the demand-side and the intensity of regulating pharmaceuticals in general and generic medicines in particular, ranging from liberal policies on pricing (USA, UK), to reference price regimes (Germany, Canada, France, Italy, Spain), and price capping for generics (France, Italy, Spain). Of the countries that implemented reference pricing, Germany and Canada did so well before the start of the study period, whereas France, Italy and Spain introduced reference pricing in 2003, 2002 and 2001 respectively.

The selection of these molecules was made bearing in mind that, first, all molecules were common across the seven study countries; having a set of common molecules ensures that comparisons can be made across the study countries. Second, sales of the selected molecules accounted for 19% of (generic) retail market sales, therefore, namely, a significant proportion of the total retail (generic) pharmaceutical market in the study countries. Indeed, all molecules were included in the list of the top-40 generic molecules by sales in the study countries and over the study period. Third, the selected molecules represent a mix of molecules whose patents have expired either before or during the study period. In this manner, the sample enables comparisons and analysis of mature products (e.g. amoxicillin, salbutamol, hydrochlorothiazide) and products recently gone off-patent (e.g. lisinopril, simvastatin, omeprazole). Fourth, every possible endeavour has been made to ensure that molecules have been selected across different therapeutic categories; this enables the capturing of individual product or therapy area dynamics (e.g. seasonal surges in antibiotic demand, particularly for amoxicillin or clavulanic acid; long-term therapy, esp. with lisinopril, omeprazole, but, also salbutamol and simvastatin). Finally, the sample contains both leaders in their respective product categories (e.g. salbutamol was the first in its category and simvastatin was the leading statin from a market perspective, and also the first that went off-patent in most study countries), but also followers (e.g. lisinopril and paroxetine, in the ACE inhibitor and SSRI classes respectively).

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Sales, price, and volume data have been extracted for the thirteen study products, alongside the number of competitors per product. The data was available at presentation [put-up] level for each product and company (e.g. lisinopril, 20mg, 28 tablets, manufactured by ratiopharm). This resulted in a total sample size of N=132,000 observations. Prices and sales were expressed at public prices, payable by insurance funds. However, the relevant margins for wholesalers and retailers and VAT rates were available should reference to ex-factory prices be considered. The study period ran from 2000 to the end of the first quarter of 2005 and data was available in quarterly format. IMS price levels for each product presentation were benchmarked and validated with national sources.

By selecting molecules, rather than brands, we were able to include all possible products (originator brand and all branded and unbranded generics) that were available for each molecule. This also enabled us to distinguish between different manufacturers for the same molecule. The analysis includes prescription-only medicines (POMs) and excludes any versions of the selected products that may be available as OTC. The sample also excludes any pediatric forms of the selected molecules. The sample enables the comparative study of diffusion of generic medicines in the selected countries, the price patterns of generics post-patent expiry, as well as the price difference between originator brand and generics. By being able to observe the entire range of prices post patent expiry (lowest vs. highest) and the range in generic drug diffusion by country, it was also possible to observe entry and exit by both originator and generic manufacturers as well as pricing patterns over time. This also enabled the calculation of any savings foregone to health insurance due to (a) poor diffusion of generics, compared with the best performer, and (b) higher prices compared with the lowest available in the study countries. Box 1 outlines the methodology implemented to calculate (a) the diffusion of generics, (b) the prices of generics versus brands, (c) generic price comparison across countries; (d) price decline one and two years post-generic entry and (e) the impact on stakeholders, such as health insurance, the Treasury (in terms of VAT), the distribution chain in terms of margins (wholesalers and retailers), and generic manufacturers.

3.2.2. Diffusion of generics. Generic products may achieve significant market shares in volume or sales terms. The evidence from the literature suggests that there is significant variability in the diffusion of generics in individual countries, ranging from 10% to 55% of the entire pharmaceutical market (Table 3). This is inextricably linked to the type of generic policies on the supply- and demand-side and the intensity with which they are pursued.

Despite the proliferation of policies encouraging the extensive use of generics in the sample countries, our evidence suggests that few countries have achieved a very high level of generic penetration in volume (number of prescriptions) or sales terms (>50% of total number of prescriptions) (Figure 1). Italy France and, to a lesser extent, Spain and Canada, have significantly lower generic penetration rates compared with the USA, the UK and Germany. As the remainder of the current diffusion rates are currently filled by branded medicines, at least four of the seven study countries can still realise significant savings by switching to generic consumption, provided the prices of the latter are lower.

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3.2.3. Brand vs. generic (volume adjusted price index). The evidence from the literature suggests that prices of generics post patent expiry decline fast and, often, very significantly (Table 3), whereas those of originator brands may actually increase. The latter effect has been branded as the generic paradox. The evidence that has emerged from the study at hand suggests that we different patterns may be emerging in different countries. Figure 2 summarises the price evolution during the study period for both brands and generics.

In comparing originator brand vs. generic price evolution across countries, measured as the change in original brand and generic prices since generic entry (or since the start of the study period where entry occurred before 2000), Figure 2 shows that originator brand prices increased more in the US than in any other country – a confirmation of the generic paradox, while generic prices decreased more in the US than in any other country. In the UK, generic prices also decreased substantially, but originator brand prices fell compared with baseline. While the generic paradox cannot be confirmed in the UK sensu stricto, it does appear, however, that originator drug prices were sluggish downwards more so than in other countries. The findings in the US and the UK are in contrast to the rest of the study countries, where reference pricing also applies, where originator brand prices appear to have decreased by more than generic prices, perhaps because had they remained higher, the reference pricing regulations would have forced patients to pay the difference, thereby resulting in a collapse of original brand market share (since patients would liked have switched to the generics). Thus, in order to maintain market share, it seems that original brands in reference price systems are forced to decrease their prices, and are therefore not able to pursue the same paradoxical strategy as original brands in the UK and US. The result is price convergence between original brands and generics in reference pricing countries, while price divergence occurs in the UK and the USA.

3.2.4. Price variability (evidence for individual products). By drawing on country price indices and despite evidence (from the USA and the UK) that prices of genericised molecules drop significantly once their patent expires due to generic competition, we find that in several European countries, prices are rigid downwards and do not decline significantly over time. We also find that there is significant price variability for generic products across countries such that the highest:lowest ratio may exceed 15:1 for the same product (Figure 3). Overall, our findings also suggest that countries with the highest generic prices (e.g. France, Italy, Spain) are not typically those with high prices for branded drugs. This may explain why southern European countries exhibit limited generic penetration compared to northern European countries. The combination of low generic penetration and high prices suggest that health insurance foregoes significant savings which could have been realised. These savings amount to several billion US$, or over 40% of total current expenditure for generics in our sample. This finding provides a quantitative indication of inefficient use of resources in health care.

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3.2.5. Cross country price variability. In order to compare the generic price evolution for the basket of products in our sample, a price index was calculated for each country, covering the entire study period and applying to all molecules (Figure 4). This enabled the direct comparison of price evolution per country for all products. The basket contained products whose patents expired before the start of the study period and products whose patents expired within the study period. Patent expiry dates, although different, were comparable (i.e. a few quarters apart at most) across all countries. The country level generic price evolution shown in Figure 4 is an aggregated measure of each products’ generic price index evolution, weighted by its corresponding generic market share, defined as the total generic quantity sold for this product as a share of the total generic quantity sold for all the products in the basket.

Figure 4 shows that generic prices evolve differently over time in the seven study countries. In some countries, generic prices decline furthest (UK, USA), whereas in others they decline at a lower pace (Spain, Germany); in some countries, generic prices remain static (Canada), or may even increase (France, Italy). It is important to note that because the product level price indices were based on manufacturer price indices, the resulting product indices were sensitive to changes in the mix of product presentations sold by a manufacturer. In other words, if a manufacturer introduced more presentations into the molecule market, for which, through any form of product differentiation, it increased the price, this would be reflected in the form of a higher generic price index for that manufacturer. This phenomenon was rather widespread in France and Italy and, less so, Canada, which essentially explains why in these countries the generic price index appears to be rising than declining.

In the UK and the USA, the standardized, volume adjusted average price decline for the basket over the study period was 40% compared to baseline, but was half that in Germany (20%) and Spain (19%). The price index remained the same over time in Canada and increased in Italy and France, showing increase rather than decrease in price levels.

Overall prices in our basket declined most in the only two countries that do not exercise price controls on generic medicines. Indeed, the UK and the USA are two countries that do not have a reference pricing system in place, whereas all other study countries do. This appears to suggest that where (off-patent) drug prices are determined by market forces, competition reduces them further compared with situations where reimbursement regulation and controls apply. In the case of Germany, the products’ patents expired much earlier than in the US and the UK. This would lead one to predict that the prices in Germany would have declined much more than in the US and the UK, where there was less time for competition to take hold. However, the evidence presented in this figure shows the opposite to be the case: despite experiencing earlier patent expiration, prices in Germany declined less than in the US and the UK. This indicates that reference prices, where they exist, seem to be a stronger determinant of generic price evolution than time since generic entry.

When comparing across reference price countries, Figure 4 indicates that as expected, less time since generic entry correlates with relatively higher prices. For example, in the case of France, many of the products in the sample had just expired, possibly explaining the lack of price decrease. This was indicative for products such as

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Lisinopril (available as generic for two quarters during the study period), Methylphenidate (four quarters), and Omeprazole (four quarters). Despite the short time span for their availability as generic, it seems that generic prices increased rather than decreased compared with baseline at first (generic) entry. Again, the variation in the mix of presentations at the manufacturer level may explain this price increase. This cannot be explained by seasonal effects as none of these products are affected by seasonal variations in demand, and is indicative of the presence of additional factors at the product level, exerting influence on prices. For instance, it may be the case that competition is determined at the presentation level and is reflective of the market shares that individual products achieve.

In conclusion, prices in reference pricing countries seem to be relatively static over time, whereas in non-reference pricing countries, prices seem to have decreased furthest over time. Importantly, price evolution is indicative of what is actually being dispensed on the market, rather than what is available, thus reflecting demand side conditions, i.e. the actual market shares, as well as the prices themselves.

3.2.6. Generic price reduction one and two years post patent expiry. One useful indicator of generic price decline is the price reduction one and two years post generic entry. The available empirical evidence from the USA, based on a number of molecules, suggests that generic prices (index-based) decline significantly and, in any case, by a quarter one year after first generic entry and by a third, 2 years after first generic entry (Grabowski and Vernon, 1987). This suggests that, in a US setting, there is some competition among generic products following generic entry, which leads to all generic prices declining further in the second year after the first generic entry.

When testing the above hypothesis for the product basket analysed in this study, the results reveal a slightly different picture (Figure 5). Having built volume-adjusted price indices at molecule level, and, therefore, having taken into account the different product specifications (presentations) and number of competitors, it is found that, first, the results broadly confirm the US findings above, although on certain occasions prices do not decline in the second year post patent expiry. The UK displays comparable results to those of the US and adheres to the same paradigm of price decline one and two years post generic entry. In all other study countries, however, prices were sluggish downwards, both one and two years post first generic entry (e.g. lisinopril and salbutamol in Italy). This was probably more expected in France and Italy, and probably also, Spain, where generic markets still lack depth, but was quite surprising in Germany and Canada, two countries which have significant tradition in generic prescribing and use. In certain cases, generic prices rose rather than declined in the second year post patent expiry. Overall, this result seems to suggest that in settings where generic prices are determined by third party payers through direct intervention (e.g. reference pricing, price capping), prices do not necessarily decline as fast as in countries where no such regulatory framework exists (UK, USA).

4. DETERMINANTS OF GENERIC PENETRATION AND COMPETITION IN GENERIC MARKETS

4.1. Conceptual framework

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The theoretical debate lacks empirical evidence on how best to model competition in patent-expired (generic) markets. Conventional wisdom would suggest that following patent expiry, the entry of several generics leads to commoditisation of a particular product market, resulting in price competition and reduction in prices altogether. This behaviour could be captured by a Bertrand model (Tirole, 1988). Yet, the empirical evidence indicates that the competition game is more complex than this for two reasons: first, the generic paradox (Frank & Salkever, 1997; Kanavos & Costa-Font, 2007), suggests that prices of originator brands may still increase post-generic entry and second, generic entry occurs by many firms, who come in at a discount compared with the originator brand price at patent expiry. It appears, therefore, that the behaviour of generic entrants, may be more accurately described by a Stackelberg model rather than a Bertrand model (Stackelberg, 1952; Tirole, 1988).

Taking into account the above observations, in this section a simple conceptual point of departure is developed with a view to exploring empirically the research questions at hand. Let us assume that N firms compete in a product market characterised by patent expiry that is defined by a demand function

)(QPPi = (1)

with

itit NqqQ −+= (2)

where i refers to the branded originator product and –i all other, namely generic, competitor products. Of the N generic products we assume that N-1 generics are Stackelberg followers and strategic substitutes ( 0/ <∂∂ −ii qq ). Assuming a twice differentiable and concave profit function, then there is a reaction function

, so that the profit function is: )(∑ −= iii qRq

KqRqPq iiiiii −+=Π ∑ −−

− ))((, (3)

where K refers to sunk costs. Given that generic firms are assumed to be all equally competiting on quantity, , the originator’s reaction function is represented by:

)( ti Nqq =∑ −

),()( tititii NPqqRq == − (4)

As a result the originator’s equilibrium price will be a function of:

)( ti NqqQ += (5)

as follows:

),( itiit NqP = (6)

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Equation (6) suggests that originator prices will continue to fall as higher number of competing generic products enter the market. These results will be affected by potential collusion between incumbent firm(s) and entrants which could determine some form of kinked reaction function. Assuming that price in a particular market is partly determined by regulation5 rather than competition, new entrants may decide to compete either on product attributes, or by offering better terms to distributors and generating preferential agreements instead. Indeed, the pattern of differentiation in the generic market resembles more horizontal product differentiation (Frank and Salkever, 1997), and is based on product characteristics, such as number of dose forms per molecule, method of administration (oral, e.g. tablet, capsule, pill, or suppository, or injection) packaging and pack sizes, rather than vertical product differentiation, where product competition is based on product quality attributes, such as side effect profiles in addition to brand loyalty. Whether horizontal or vertical product differentiation actually occurs in practice largely depends on the incentives present on the market, and particularly on the process of regulation and drug reimbursement prevailing in national markets.

Generic penetration and pricing are two simultaneously determined decisions driven by firms’ attempt to obtain an expected return (profit) after facing entry (sunk) costs and adjusting a product to the required characteristics that differ from country to country through product differentiation. Accordingly, one might expect prices to adjust to changes in quantity and the other way around. We first model generic penetration as follows:

),,,,,( 1 RWRPNq ii Ω=− (7)

where generic penetration (q-i) depends on the market structure ( ), current prices for each product , which are potentially affecting the existing price margin once the product enters into the market along with product characteristics affecting quantity (

N)( iP

)1Ω , reimbursement , and other market regulation, notably on wholesaling (W) and retailing (R) and that would affect the extent of generic penetration.

)(R

On the other hand, drug prices both total ( are determined as follows: )iP

),,,( 2 RqNP ii Ω= − (8)

Drug prices are determined on the basis of current generic penetration ( which affects current profits, the market structure ( ) along with product characteristics affecting

)iq−

N 5 Regulation in this context could be on the supply-side or the demand-side. Supply-side regulation mainly affects the price and relates to price fixing or setting a reimbursement rate or setting a reference price (maximum reimbursement rate). Demand-side regulation relates predominantly to cost-effective and incentive-based physician prescribing and dispensing policy (margins and generic substitution).

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prices ( , so that the system is identified and reimbursement and regulation of market conditions such as wholesaling (W) and retailing (R) that would affect the extent of generic penetration.

)2Ω )(R

The entry of a generic product into the market is affected by the existing market entry barriers; these are purely regulatory and imply demonstrating bioequivalence to the originator brand product, but can also be related to price capping and regulation. Some of these regulatory practices may be unique to individual countries, as suggested elsewhere (Reiffen and Ward, 2005). As a result, the new entrant’s time of entry is not under his control and, accordingly, each product market, once genericised, may be subject to sequential entry.

The importance of regulation is clear in the presence of switching costs. Indeed, one of the reasons for limited generic penetration is the existence of switching costs (Hollis, 2002) and to success either they need to persuade consumers of a higher quality or give a lower price. Yet, the existence of regulation might affect the extent to which generic penetration differs across countries.

Non-linear entry

Empirical evidence suggests that the penetration of new companies in a particular industry or market segment may be characterised by non-linear entry, where, initially, a small number of companies exert little influence in driving prices down until a certain number of companies is reached and competition occurs until there is congestion in that market (Reiffen and Ward, 2005). Yet, this pattern differs from industry to industry depending on market entry barriers. In the pharmaceutical sector, market barriers are related to or influenced by existing regulation, therefore, the process through which one would expect to observe increasing generic penetration may be country-dependent and regulation-specific. Consequently, non-linear effects may be attributable to a host of variables.

The market for prescription medicines is affected by significant imperfections given the multiplicity of stakeholders (insurers, physicians, patients) as well as the presence of an array of potential market barriers to entry from strategic pricing to regulation or government induced barriers. Very often, the first generic entrants are “branded” generic medicines, namely generics who promote a brand for a certain molecule and, in doing so, they would charge a price premium. The first wave of generic entrants (branded generics) will subsequently be replaced by no-branded generics, who essentially compete on price. As the formers’ business model is different from the latters’, the former may altogether exit, thus leaving the market to un-branded generic competition.

In addition, insurance companies6 may not be able to promote generic competition adequately and, accordingly, generic drugs are able to free ride on originators’ market power rather than face market competition. This is in part due to legal and regulatory barriers, which differ depending on the setting. From a consumer

6 These can be statutory sickness funds or private health insurance companies.

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perspective, individuals face switching costs when choosing a generic alternative, which includes the opportunity cost of obtaining a generic prescription following a medical consultation. At the same time, despite generics being bioequivalent, and, therefore, close substitutes to originator drugs, in practice some form of differentiation may exist and consumers may exhibit some “status quo bias”. Physicians might also respond positively initially to the entry of new drugs but they are not always sensitive to prices, simply because their knowledge on prices is limited (Gaynor and Polachek, 2002).

Non-linear effects may also be the result of promotional effort of originator companies that disappear after a certain number of substitutes enter into the market, or simply the effects of strategic entry by generic manufacturers. That is, entry responds to the degree of competition so that when a specific therapeutic group competition overcomes a certain reference level then it encourages companies to leave the market and get into other submarkets less exposed to competition. One might expect that the level of competition (or concentration in one market) will discourage generic entry so that non-linear patterns may be observed following exit by some incumbent firms due to fierce price competition so that only a limited number of companies survive competition. Finally, an explanation for non-linear pricing refer to the existence of collusion in the market.

Evidence of non-linear effects has been reported in explaining generic penetration in Canada study (Hollis, 2002), where quantities are explained by a quadratic effect, suggesting that the first entrants in a particular market still have significant market power. Non-linearities are also identified in a US study on prices (Reiffen and Ward, 2005).

4.2. Empirical Strategy The same IMS dataset of 13 products over the 2000 – 2005 period across 7 OECD countries was used to analyse: (a) the determinants of originator prices, (b) the determinants of generic prices; (c) the determinants of aggregate generic penetration and diffusion; The dataset covered 13 products over 6 years on quarterly basis across seven key OECD countries.

4.2.1. Econometric Specification. The econometric strategy followed in the paper comprises two distinct parts, the first is aggregate in nature and is aimed at aggregate product (molecule) level, whilst the second is aimed at product presentation level. In both parts, the originator and generic markets are fully observable. The analysis at product level aims to identify the predictors of generic prices and generic diffusion at aggregate level; it also aims to determine whether originator prices are affected by the entry of generics in a mature market. As certain variables, particularly the effect of price regulation, are only observable at the product (molecule) level, the aggregate level analysis is pursued first using price index data for both originator and generic versions of each product and generic penetration levels at the country level along with regulation-specific variables, such as reference pricing and the impact of wholesale and retail distribution. This could lead to the identification of factors influencing generic competition, diffusion of generics and the likely impact on the savings from generic medicines to health insurance.

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In the second part, we take advantage of the disaggregated nature of our data where we can observe prices and volume for all competitors at the lowest possible available level (product presentation), clustered by product and company. This gives rise to an extensive dataset where it is possible to account for product-specific effects. In this way we can pursue similar questions, namely the extent of generic competition, the factors that determine diffusion of generics as well as the extent to which originator brand prices are affected by generic competition. We are also in a position to pursue country level analysis of the determinants of generic competition, and, therefore, identify similarities and differences across countries.

For the aggregate-level analysis the variables employed were: the total generic market share ( ), the originator price index ( ), the generic price index ( ), the wholesale margins for each country and year (WMAR), the retail margins for each country and year (PHMAR), the number of pharmacies per 1000 inhabitants (NPHA), a time trend (TREND) and a dummy for reference pricing (RP) for the countries that actually implement it (Germany, France, Italy, Spain, Canada). As the introduction of reference pricing differs by country, the actual date of introduction has been identified and employed in the analysis. For the analysis at product presentation level the variables employed were: the price at presentation level per mg (LP); the price difference between originator and generic medicine, in mg (LPD); the total market size at product level measured in unit terms and applied at product level (LTQ); the number of units per presentation measured in mg (LQ); the reference price, identified as the lowest price for each product presentation across all competitors in a given product cluster (RP); the number of competitors for each product and product presentation at each point in time (N); the number of formulations (whether pill, capsule, injectable or suppository) per product (NFORM); the number of product presentations (pack sizes) per product (NPRESE); the strength for each product, reflecting dosage forms (STRENGTH); and the defined daily dosage (DDD) as a measure of need. A list and brief description of all variables employed in the empirical analysis is provided in Box 1.

iS origiP gen

iP

4.3. Generic paradox, generic competition and diffusion at aggregate level At aggregate level, price and generic penetration are observed at country level for

a basket of similar products. The influence of a time trend is also considered along with country-specific regulation effects. All study countries have policies that to a large extent encourage the use of generic medicines, although these may be pursued with different intensity. The most important aspect of regulation affecting pricing and reimbursement of generics, and, consequently, market share and utilization, in 5 of the study countries is reference pricing (Germany, France, Italy, Spain, Canada). Given that this type of regulation does not affect the UK and the USA, we introduced an interaction between generic competition and the reference price system to examine the influence in those markets that implement reference pricing. We are interested in examining three main variables, namely, first, the predictors of originator brand prices in an environment characterized by generic entry, second, the determinants of generic prices

in product markets characterized by multiple entry of substitutes, and, finally, the

)( origiP

)( geniP

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factors explaining generic penetration ). Accordingly, three specifications were estimated:

iS(

ηααααα +++++= TimeRPRPSSP iioi 4321 *orig (9)

and we tested the effect of 42α α− =0 to examine the sensitivity of the results to consideration of any reference price effects. Next, the determinants of generic prices are explored. In this case, we estimate the following equation:

εββββββ ++++++= iiioi PTimeRPRPSSP 54321 * origgen (10)

Again we undertook several specifications where 42β β− =0, so that the reaction function of generic prices to both other generic competitors as well as to the originator price could be estimated at an aggregate level.

Finally, given that the ultimate static welfare improvement for public and private insurance holders overall is the existence of cost savings from a wider prescribing and utilization of generic medicines, we examine the aggregate determinants of generic penetration so as to identify the key potential diffusion drivers taking into account the main stakeholders in this process. The influence of competition in the distribution chain is considered at this stage by examining the effect the total number of pharmacies have in each country. The rationale behind the inclusion of this variable is that pharmacies are essentially the executors of generic policy on behalf of health insurance (both public and private). Pharmacies receive margins and discounts for payment and they are also allowed to substitute for cheaper generics if the latter are available. The influence of price has also been added, as it could capture the effect of regulation in the price determination. In this context, we consider both the base where prices are endogenously determined using as instruments the official and negotiated wholesale and retail margins. Finally, we include a time trend and as well information on whether the country has a reference price system in place of not. Overall, the empirical specification was as follows:

μβδδδδ +++++= TimeretailerNRPPS ioi 4321 gen (11)

At this level, the sample size comprises 140 observations (N=140). We employ OLS and, when required, we instrument the required variables. The results of the aggregate level analysis are shown on Table 4.

The upper panel of Table 4 summarises the evidence on the determinants of originator brand price index. We find that when no controls are included generic penetration, proxied by generic market share, has a non-significant effect on the aggregate price index. The relationship between originator brand price index and generic market share is negative, as intuitively expected, yet the effect is not statistically significant. On aggregate, this implies that prices of originator brands are not significantly affected by the expanding market share of generics. When a time trend in added and an interaction with reference prices is included, there still is no significant effect on originator brand prices, even though generic penetration seems to have a

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measurable effect on prices (11% reduction), which is, nevertheless, not significant. This result suggests that in countries that use reference price regulation the effect of generic competition on originator brands is moderate and not significant.

When the determinants of generic prices are considered (Table 4, middle panel), the effect here suggests that a doubling of the generic market share, reduces the generic price index by 11%. The effect is negative and significant and is suggestive of competition in the generics markets of the seven study countries. Interestingly, when an interaction is added between generic market share and reference price, the result is that the effect of competition in countries where no reference prince exists doubles and the effect is statistically significant, whereas in countries where reference pricing exists, the effect is modest and non-significant. This implies that out of the seven study countries, only in the UK and the USA does there exist price competition at aggregate level as generic penetration intensifies. In all other countries (Germany, France, Italy, Spain, Canada), regulation, in the form of reference pricing, seems to have a negative effect on (price) competition. With regards to the relationship between generic price index and originator brand price index, this is positive and significant and seems to suggest a leader-follower relationship. Overall, the originator brand price effect is greater than the effect of generic competition itself. It appears that, on aggregate, there is a co-movement between originator brand and generic prices.

Finally, Table 4, lower panel, summarises the determinants of generic penetration, by using both OLS and IV. Whereas generic prices are endogenously determined as confirmed by the Hausmann test, instrumentation leads to marginally different results. It appears that generic prices are a strong determinant of generic penetration; the relationship between the two is negative and significant as expected. The number of pharmacies also features as positive and significant, which is a confirmation that demand-side policies at dispensing level critically influence diffusion of generic medicines. This finding also implies that greater competition among pharmacies increases generic penetration. Finally, the relationship between the reference price and generic penetration is positive and statistically significant; it essentially means that the higher the reference price, the greater generic penetration is. This finding implies that the reference price acts as a signal to more generic competitors to enter the market. This may be due to the reference price being perceived as a stability factor by new entrants.

4.4. Generic entry and competition at product presentation level In the second part of the analysis, and in order to maximize the information

available, we construct a panel of all products for the seven study countries at the presentation level. A dual estimation strategy was followed in this part: first, a hierarchical Generalized Linear Model (GLM) Approach was employed, which provides similar results to OLS, but allows the examination of competition effects around the product; and, second, a random effects Generalised Least Square (RE-GLS) specification, to take account of the panel nature of the data.

Three different decisions were examined in this context: first, an analysis of how generic prices are formed, their determinants and whether there is evidence of regulation-induced effects as well as competition. Both prices and product volumes are observed at

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product presentation level, which is the most disaggregated level. Decisions to enter a particular presentation impact all molecules, whether their patent has expired before 2000 or during the study period (2000 – 2005). Second, we examine the factors that determine the potential savings that a higher generic penetration would yield as compared to the same prescription being filled using an originator brand. Finally, we examine the determinants of generic penetration or diffusion. as in previous specification we are interested in the influence of market volume which could indicate the extent to which a market is already saturated along with the number of competitors I the presence of entry and exit. The advantage of using disaggregated data at the presentation level is that the data allows us to consider the effect of product differentiation by adding the number of presentations, formulation the strengths of the defined daily dosage into the equation. The system is identified through the use of a set of instruments, discussed below.

The competition effects on the generic market (generic competition) are examined by using the specification below. The fist variable to examine is generics prices as follows:

itRP

itittitG PNNNP εωββββββ ++++++Ω+= 5

34

23210

RPitP

itRP

itittorg

ititG PNNNPP εωββββββ ++++++Ω+= 5

34

23210/

32

(12)

which includes Ω that measures product characteristics, N refers to the number of competitors which is included both in quadratic and cubed terms to measure the effect of nonlinearities, as they may arise from generic entry post patent expiry. Furthermore, we introduce a variable that measured the effect of the reference price which is measured as the lowest generic available for each product times an interaction factor for the 5 countries that implement reference pricing.

Subsequently, we measure the influence of the same determinants on savings to health insurance at the product level by examining the difference between price of each generic presentation and that of the originator brand.

(13)

Finally, the last effect that would determine overall savings from generic competition is the extent to generic diffusion . The specification below considers generic penetration as a linearization of equation 5 as follows:

)( itG

ititittit NNNQG εββββββ +++++Ω+= 543210 (14)

Given that the profitability of generic products would depend on the difference with the branded price, we subsequently simultaneously determine the effect of market competition and generic penetration on (a) the prices of all products, generic and branded, and (b) prices of generic products only. Product differentiation is measured using price and volume data at presentation level. Market structure is measured using available data on (a) the number of competitors in each product segment, (b) the number

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of competitors squared and (c) number of competitors cubed, so that non linear competition effects are considered. Regulation-induced effects (Rizzo and Zeckhauser, 2005) are included through the dummies omeasuring the effect of reference pricing.

Given that we work at the presentation level we examine two separate effects, one at presentation level, the other at product level. The volume effect on prices (or prices over volume) capture the impact on prices (or volumes and, therefore, market share) at the presentation level, while the effect of competition is examined by including the number of competing companies at the product level. Accordingly, the econometric estimation will provide evidence on: (a) determinants of drug prices (originator, generic, and overall) in the presence of generic entry (b) determinants of drug prices savings (originator, generic, and overall) in the presence of generic entry; (c) i determinants of generic penetration (volume effect). Given that for each product in the sample we can observe each presentation volume we estimate an extended reaction function reduced form that would allow us to disentangle the extent to which prices are sensitive to the expansion of volume and allows us to determine whether price competition conforms with a Cournot, a Bertrand, or a Stackelberg model. The data has allowed the composition of a panel containing data for 13 products in 7 countries over 6 years on a quarterly basis. By taking into consideration the effect of some attrition and the influence of entry the average sample size is N=108,150. Tables 5, 6 and 7 provide the results of the panel data models for price formation, price savings and diffusion.

Table 5 summarises the results of the entire dataset. The upper panel shows the predictors of generic prices and suggests that there exists evidence of nonlinear competition influencing generic prices; however, when the panel nature of the data is taken into consideration the effect of nonlinear competition disappears. Nevertheless, the variable that consistently explains generic prices is the reference price in countries where a reference pricing system operates. This is not surprising as regulation in these countries caps the effect of competition through the reference price, and, consequently, the relationship between the two is positive, indicating a downward rigidity of generic prices in the presence of a reference pricing system. There are also product differentiation effect suggesting that product differentiation plays a marked role in price formation over time. In explaining diffusion (Table 5, lower panel), we find that it is mainly driven by the degree of market saturation: the greater the total market size, the lower the diffusion of generics. This may, at first glance, appear counter-intuitive, but is indicative of the situation in four of the seven study countries (France, Italy, Spain, and, less so, Canada), which still provide significant possibilities to expand their generic markets. Similar appears to be the case for individual products at presentation level and across countries. Competition does not appear to have an effect on diffusion, but aspects of product differentiation do.

Finally, Tables 6 and 7 provide the country results for price competition and diffusion respectively at the individual country level. The results from Table 6 suggest that the number of competitors at the product presentation level is an important predictor of price competition in Canada, France and Spain only. In both countries, the relationship is negative, suggesting that new entry will have a downward impact on price. Furthermore, in both countries, there seem to be non-linear effects, such that prices decline further if the number of generic entrants increases by N3; the effect is,

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nevertheless, very small. Generic prices also respond to the reference price that is determined by the authorities, although in France the effect is positive as not all products are affected by the reference price, since it was only introduced in mid-2003. In Italy, the effect of competition on generic prices is positive and significant, but opposite to the one that would be intuitively expected. The explanation for this effect is that product differentiation applies in the Italian market, such that there is exit and subsequent entry in the same product presentation market, but at higher price upon re-entry. As in the case of France, the impact of reference pricing is positive reflecting its late introduction in the Italian market. In Germany, the country with the highest number of generic firms per product, the number of competitors does not seem to have any effect on the price of generic drugs. This appears to be counter-intuitive, but, when combined with the sizeable, negative and significant association of generic prices with the reference price, can be interpreted to mean that any downward effect on generic price is through the reference price. In the UK, generic competition has a strong upward effect on prices it may also affect generic prices downwards, but there has to be a certain number of firms for this effect to take place. Finally, in the USA, contrary to expectations, competition, measured by the number of generic firms on the market, has no statistically significant effect on generic prices. Overall, we find little evidence of price competition via the association of generic prices with the number of generic firms, particularly in countries where such an effect was intuitively expected (Germany, USA and UK). In addition, reference pricing regulation seems to influence prices and, in the case of Germany, any significant effect on generic price is through the reference price.

In Table 7 we examine the extent to which the number of generic competitors influences diffusion of generic medicines. This is not the case in Canada, Germany or France, but it is the case in Spain, Italy, the UK and the USA. In these countries there are also nonlinear effects, with the exception of the UK.

Overall, we find that there is nonlinear competition as predicted in the seven study countries and that reimbursement regulation through reference pricing may stave off price competition altogether. In addition, in countries where there does not appear to be price competition (UK, USA), there is evidence of volume competition instead.

4.5. Summary of results Having undertaken aggregate level analysis of the determinants of originator drug

prices in the presence of generic competition, the determinants of generic drug prices and the determinants of generic presentation, we find that originator brand prices are not affected by increasing generic competition; that countries where no reimbursement regulation exists for generics, show greater competition than countries where reimbursement regulation is implemented; that originator brand prices influence generic drug prices in a relationship that seems to resemble a leader-follower paradigm; and that generic penetration is facilitated by lower generic prices, by greater pharmacy competition and higher reference prices.

The analysis at presentation level suggests that several countries still have significant possibilities to capitalise on generic penetration and that significant possibilities also exist at product presentation level overall. We also find that there is

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nonlinear competition as predicted in the seven study countries and that reimbursement regulation through reference pricing may stave off price competition altogether. In addition, in countries where there does not appear to be price competition (UK, USA), there is evidence of volume competition instead.

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5. POLICY IMPLICATIONS The aggregate level results indicate that there is overall evidence consistent with

the generics paradox. Interestingly enough, there is space for generic penetration to have a further effect on prices and that the potential of generics may not have been fully realized. The extent of competition in the market for generic drugs is largely dependent on the regulatory framework. Regulation, in turn, is highly dependent on the incentives associated with the reference prince system. A Stackelberg model seems to explain reasonably well how generic products behave as originators price is taken as a reference for generics price whilst competition has only effects inc countries not subject to reference pricing. At product presentation level, diffusion we find that is driven mainly by the extent of market saturation, which probably gives rise to exit as Caves et al (1991) argue and provides further credence to the argument that the potential of generics may not have been fully realised. The evidence of non linear effects is consistent with the idea of two stage Stackelberg game where early generic entrants compete with originators and the latter compete with newer generic entrants. In-between, there may be exit by some of the first wave of generics and entry by lower cost generics.

The study results have important implications for health and pharmaceutical policy. First, it appears that generic entry does not have an impact on prices in the generic market segment over time, as originally thought, with the exception of the US and the UK. This suggests that generic prices are sluggish downwards and this may be due to pricing and reimbursement regulation or slow uptake of generic medicines. The direction of non-linearities in the German case points to that direction. Eliminating pricing and reimbursement regulation measures that disallow generic prices from declining fast over time might reverse this trend. Similarly, implementing demand-side measures that increase the acceptance of generics and their consumption could have a comparable effect in countries where generics are still not used widely.

Second, the number of generic entrants is not necessarily a predictor of lower generic prices in the USA and Germany, two of the countries with the highest generic penetration and use, and is a predictor of higher generic prices in the UK. The number of generic entrants was associated with price declines in the generic segment in the other study countries. This suggests that entry by generic producers is in itself a necessary but not sufficient condition for a sustainable reduction in generic drug prices for payors and that the product mix as well as factors related to in-product characteristics may have an adverse effect on generic price reduction irrespective of the number of players entering the market.

Third, generic entry does not have an impact on originator drug prices. This suggests that in order for payors to draw benefits from genericisation, a switch has to take place from the branded originator drug to generic equivalents. Failure to do so implies that health insurance will continue to pay premium prices for products whose patents have expired.

Fourth, product differentiation has a positive effect on generic prices rather than negative. This suggests that competition does not occur at the product level, but at the presentation level. The results of the product differentiation variables, such as strength

WORK IN PROGRESS 33


(dosage) and form, confirm that generic entry is impacted by choices on both strength and form of the presentation in question.

Overall, the analysis suggests that competition is variable and country-dependent, and that other factors are key determinants of generic competition, namely regulation and product differentiation. Our study presents some limitations. First, it could be argued that the study period is short, therefore might not allow sufficient space for dynamics to be explored. The way we have addressed that is by selecting balanced sample that includes older products and products whose patents expired during the study period. Second, whereas the sample does not allow us to look at therapeutic competition as the data is not grouped into therapeutic groups we examine competition patterns across different therapeutic areas. Yet, this might be a logical extension to this research.

Cost containment in the field of pharmaceuticals will continue to be high on the agenda of decision makers. If about two thirds of the global pharmaceutical market, currently valued at approximately $1.1 trillion, consists of molecules whose patents have expired or are already subject to generic competition, then generics are an obvious target for containment and achieving savings to fund additional health services and innovation upstream. With a strong push at international level, particularly in OECD countries, to develop generic markets and encourage the prescribing of generic medicines, policy makers have identified that using generic products, should in general, be cost-effective, because they could lead to savings for health insurance and increase overall technical efficiency (Busse and Howorth, 1999).

Policy makers, however, need to be mindful of four important outcomes from such policy adoptions. First, an increase in generic medicines uptake does not necessarily imply that the total pharmaceutical expenditure will decrease, so implications for cost control are not always as straightforward. For instance, even if price control measures are put in place an increase in volume could result in an overall increase in pharmaceutical expenditure. Moreover, even if direct cost savings occur to consumers, an increase in volume, however, may be necessary to meet patient demands. Furthermore any increase in pharmaceutical expenditure could offset costs elsewhere in the health care system, but it is necessary that the use of medicines be rational (Mrazek and Mossialos, 2004).

Second, decision-makers need to be aware of existing policies that operate within their regulatory framework, and whether the interaction with other policies—supply with proxy demand policies—are aligned in such a way that the net effect of generic uptake is encouraged rather than discouraged. In other words, generic uptake will not only depend on supply side policies but also proxy demand policies, that is the argument for more or less direct pricing policies need to be balanced against other policy measures in place.

Third, when referring to competition in generic markets policy-makers need to be aware that competition may not necessarily focus on prices and that (generic) entrants will have an incentive to differentiate in an otherwise homogeneous product market in order to maximize returns. Product differentiation may include (a) altering some of the product characteristics (dose, pack size, delivery), (b) focusing only on some aspects of a product market (e.g. launching in some rather than all dosage forms), (c) offering invisible discounts to the distribution chain in order for the latter to place them at

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preferential rates on the market, or (d) exiting and potentially re-entering with a slightly differentiated product and price. In any case, policy makers need to be aware of these strategies and also the fact that the competition game in off-patent markets is most often played at the in-product rather than at the product level.

Finally, whereas it may be tempting over the short-term to introduce regulatory schemes, such as reference pricing, their existence over the long-term may hamper the delivery of dynamic benefits. Reference pricing is based on the observation of prices in the lowest segment the market at a particular point in time. This in itself will, ceteris paribus, deliver instant savings to health insurance equal to the generic volume times the difference between originator branded and generic price. However, an administrative tool that is set based on observation of market conditions is unlikely to deliver long-term results because manufacturers will be unwilling to reduce prices further significantly, knowing that health insurance will re-set reference price levels once it observes downward price movements on the market. In a nutshell and based on the available evidence it may be preferable not to intervene and regulate this segment of the market in order to achieve best results.

6. CONCLUSIONS In this paper we have examined the extent to which generic medicines deliver

significant savings to health insurers and the type of competition that characterizes generic markets. We have found that prices in the off-patent sector do not decline as fast as originally thought and that generic penetration can be improved significantly in several countries. The combined result of lower generic prices and higher generic penetration should be greater savings for health insurance, which currently are not being realised. We find evidence that the originator brand prices are not affected by increasing generic competition, consistent with the generics paradox. Within the generic segment, we find that regulation hinders competition, but also that for price or volume competition to materialize, there needs to be a significant number of generic entrants on the market. Pharmacy competition promotes generic competition, whereas elements of product differentiation within generics promote diffusion, but do not reduce prices.

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Table 1

Health and pharmaceutical spending in key OECD countries, 1995 – 2005

Country Total expenditure on health as % of GDP

Total expenditure on pharmaceuticals and other non-durables per capita, (at US

exchange rate)

Total expenditure on pharmaceuticals and other non-durables as

a % of total health expenditure

1995 2000 2005 1995 2000 2004 1995 2000 2005

Canada 9.2 8.9 9.9e 252 330 537e 13.8 15.9 18.2

France 9.4 9.2 10.5e 451 418 676e 17.6 20.3 18.9e

Germany 10.1 10.3 10.6 401 322 494 12.8 13.6 14.1

Italy 7.1 8.1 8.7 299 339 546 21.1 21.9 20.3

Spain 7.4 7.2 8.1e 217 220 447e 19.2 21.3 22.8e

United Kingdom 7.0 7.3 8.4d 209 276 430 15.3 16.4 16.6

United States 13.3 13.3 15.3 325 535 752 8.9 11.7 12.3

Note: Underlined data was not yet available for 2005, so reflects 2004. Source: OECD Health Database, 2006.

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Table 2 Generic pharmaceutical policies in 7 OECD countries, 2000 - 2006

Measure UK Germany France Italy Spain USA Canada Supply-side

Price cap1b b b b

Reference pricing2

b b b b b

Proxy demand-side Promoting Generic prescribing3

b b b b b

Compulsory generic prescribing4

b

Generic substitution5

b b b b b b

Flat or Regressive margin6

b b b b

Discounting allowed officially7

b b b b

Clawback8b

Demand-side Differential co-pays9

b

Other co-pays relevant to generic medicines

Notes: 1 Refers to the Maximum Price Scheme (MPS) in the UK, which applies to a limited number of generic medicines, as per the regulation of 1999. In all other countries applied, all generics are subject to an official maximum price which cannot be more than a certain proportion of the branded price. This is 70-80% of the branded product price. 2 Is the maximum reimbursement that health insurance will pay for a particular product. The dates of introduction differ considerably by country, as does the definition of the clusters and the extent to which they can include in-patent products (molecules). 3 Generic prescribing is not compulsory, but is in some way promoted by health insurance. This is usually combined with reference pricing and the latter implies that patients will need to be informed about cheaper and more costly choices. 4 It is compulsory as a policy, unless there are no generic alternatives available, or unless the physician believes the originator drug should be dispensed in a particular case; the policy usually also applies to in-patent products, where physicians are required to prescribe by INN. 5 The extent to which pharmacists are allowed to substitute for a cheaper product (generic) if the physician has prescribed by brandname. Substitution rights have been extended in recent years and apply more extensively as opposed to “emergencies only,” or “subject to physician approval”, although some physician autonomy still exists if the “dispense as written” box on the prescription has been ticked. 6 Reflects the method of paying pharmacists for their dispensing services. In principle, flat fees make pharmacists indifferent between branded and generics, whereas regressive margins would, in principle, favour generics.

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7 Reflects the extent to which discounts are officially allowed and practiced in some countries, in addition to whatever margins are allowed or institutionalised via national regulation. 8 Refers to health insurance retrieving part of the discount given from manufacturers or wholesalers to pharmacies. 9 Whether co-payments vary according to the type of drug being dispensed, e.g. generics attracting a lower co-pay compared with the branded version of the same medicine. Source: The authors.

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Figure 1

Generic sales as % of total sales across 13 off-patent molecules, 2005 (100% =1)

Source: The authors from IMS.

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Table 3

Pricing and penetration of generics in selected European countries, 2005

Country Average difference between branded price and generic

price 4 years after first entry (%)

Average penetration up to 4 years after first entry (%)

(potential maximum market share)

USA 63%1 49%1 (99%)

UK 80% 55% (95%)

Netherlands 50% 35% (85%)

Germany 25-30% 45% (85%)

France 30-40% 10-20% (30%)

Italy <20% 10-18% (25%)

Spain 20% 10-25% (60%)

Note: 1 After 2 years following patent expiry. Sources: The authors from IMS; Grabowski and Vernon, 1987.

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Figure 2

Generic Vs. Original Brand Price Evolution Across Countries:Generic Entry to 2005Q1

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

France Italy Canada Germany Spain UK US

generic original brand

Note: Price evolution measures the change in generic and original brand prices from generic entry to 2005Q1. Source: The authors from IMS.


42

Figure 3: Prices of selected molecules 1 year post-patent expiry (in €, volume adjusted) Generic Price of Clavulanic Acid

One Year Post Generic Entry

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Canada 04q1 Germany 00q1 Spain 00q1 UK 04q2 Italy 00q1

Euro

s

Generic Price of Paroxetine One Year Post Generic Entry

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Eur

os


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Figure 4

Generic Price Evolution Across Countries: Generic Entry to 2005Q1

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Note: Price evolution measures the change in generic prices from generic entry to 2005Q1. Source: The authors from IMS.


44

Figure 5: Generic price evolution 1 and 2 years post patent expiry, indices, selected products; 1 = patent expiry1

Generic Price Evolution of Clavulanic Acid

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Generic Price Evolution of Hydrochlorothiazide

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Generic Price Evolution of Lisinopril

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Generic Price Evolution of Methylphenidate

0.75

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Generic Price Evolution of Omeprazole

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Generic Price Evolution of Simvastatin

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Generic Price Evolution of Paroxetine

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Generic Price Evolution of Salbutamol

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`

Competition in off-patent drug markets Kanavos, Costa-Font, Seeley Note: Actual patent expiry dates for each molecule may differ per country. All graphs have taken 1 and 2 years post patent expiry, having standardized for patent expiry date. Source: The authors from IMS.

45


Box 1 Variables and their definitions for econometric analysis, 2000 Q1 – 2005 Q2

Variable Definition Mean (s.e) Variables used in aggregate analysis

iS Generic Market Share 0.786 0.010

origiP Originator Price Index (Baseline= quarter one

2000); volume and inflation adjusted 0.997 0.004

geniP Generic Price Index (Baseline= quarter one 2000);

volume and inflation adjusted 1.013 0.007

WMAR Wholesale margin per country and year 6.387 0.254PHMAR Pharmacist margin per country and tear 22.049 0.683NPHA Number of pharmacies per 1000 inhabitants 3.751 0.092Time Time Trend 2.250 0.120RP Dummy for reference price 0.607 0.041

Variables used in dis-aggregated analysis LP Price per mg (logs) 2.966 0.005 LPD Price difference between generic and originator 2.923 0.05 LQ Units in mg (logs) 5.920 0.012 LTQ Total number of units in mg average in each

country in logs (total volume) 29.3 0.07

RP Reference price - Minimum price per presentatuion (logs)

1.40 0.001

N Number competitors 36.974 0.091 NFORM Number of formulations 7.051 0.018 NPRESE Number of presentations 2.403 0.007 STRENGTH Strength for each presentation in mg DDD Defined Daily Dosage 611.796 3.443 Notes: Time subscripts omitted for simplicity. 1 j=1,…,12, for the 13 products in our sample. 2 i=1,…,7; the countries are: Canada, Germany, UK, Spain, Italy, France, USA.

46


Table 4

Determinants of (originator and generic) price competition and generic penetration (prices are indices; N=140)

Determinants of Originator Price Index [ ] origiP

Variables Coefficient SE coefficient SE coefficient SE

iS -0.017 0.037 -0.023 0.040 -0.110 0.069 Time 0.007 0.004

RPSi * 0.057 0.080

RP 0.009 0.011 -0.036 0.061 Intercept 1.011** 0.029 1.010** 0.031 -12.839** 7.633

Adjusted R2 0.02 0.05 0.07 F-Test (M, N-M)

3.01 2.56 2.01

Determinants of Generics Price Index (N=140) [ ] geniP

Variables Coefficient SE coefficient SE coefficient SE orig

iP 0.317* 0.142 0.337* 0.144

iS -0.11** 0.05 -0.01** 0.05 -0.23** 0.120 Time 0.006 0.007

RPSi * 0.114 0.143

RP -0.083 0.106 Intercept 1.09* 0.0432 0.775* 0.152 -10.73* 13.779 F-test 4.04 4.12 2.130 Adjusted R2 0.23 0.41 0.420

Determinants of Aggregate Generic Penetration [ ] geniq

OLS IV Coefficient SE coefficient SE

geniP -1.058** 0.547 -1.058a** 0.537

Time 0.034* 0.006 0.033* 0.0067 N retailers 0.0470* 0.010 0.047* 0.0102 RP 0.112* 0.023 0.112* 0.0229 Intercept -66.6* 13.76 -66.68* 13.518 Rsq 0.21 0.22 F-Test 23.01 2.13 Sargan Test 4.573 Anderson Test

6.661

Note: i Instruments are the number wholesalers and pharmacy margins. F-test significant in the first stage. *Significant at 1% **Significant at 5%.

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Table 5

Effect of generic market entry on (generic) prices, diffusion and savings foregone

(N = 108,150)

(a) Generic Price Formation Process GLM RE-GLS Coefficient SE Coefficient SE RP 0.868* 0.0075 0.042* 0.014 N 0.054* 0.0023 -0.073 0.053 N2 -0.002* 6.05E-05 0.003 0.002 N3 0.00002* 4.65E-07 -3E-05 2.61E-05 NFORM 0.06525* 0.00122 0.064 0.039 NPRESE -0.004 0.0033 -0.0947 0.0874 DDD -0.00021* 6.80E-06 -0.0002* 0.00001 Time -0.00002** 7.95E-06 -6.36E-06 8.81E-06 STRENGTH 0.003* 9.64E-05 0.0035* 0.0001 Intercept 1.375* 0.0276 3.4192* 0.3416 Wald (2,9) 712.02 Within 0.012 Between 0.24 Overall R2 0.42 0.30 F-Test 3051.7

(b) Price Difference (Generic –Lowest) GLM GLS-RE Coefficient SE Coefficient SE RP 0.518699* 0.015248 -0.46817* 0.016427 N -0.20794* 0.005023 -0.04932 0.090413 N2 0.006623* 0.000162 0.001784 0.003731 N3 -6.2E-05* 1.57E-06 -1.8E-05 4.18E-05 NFORM 0.0005* 0.000003 0.0004* 0.000023 NPRESE 0.026773* 0.001719 0.065163 0.060676 DDD -0.06867* 0.007616 -0.20094 0.149417 Time -0.00048* 1.93E-05 -0.00049* 0.2.1E-05 STRENGTH 1.73E-05* 3.32E-06 2.38E-05* 2.63E-06 Intercept -0.00074* 0.0001 -0.00069* 0.00015 Wald (2,9) 3.668328* 0.063106 3.58014* 0.625588 Within 0.0142 Between 0.256 Overall R2 0.1919

(c) Diffusion of Generic Drugs GLM GLS-RE Coefficient SE Coefficient SE LTQ -0.1753* 0.0072 -0.2744* 0.1186 N -0.1268* 0.0062 -0.0403 0.0946 N2 0.0029* 0.0002 0.0007 0.0032

48


N3 0.00001* 3E-07 0.00001* 4E-07 NFORM -0.0716* 0.0035 -0.0155 0.0825 NPRESE -0.4959* 0.0098 -0.4495* 0.2096 DDD 0.0003* 0.00001 -0.0002 0.0003 Time 0.00005* 4E-07 0.00005* 0.0000003 STRENGTH 0.0129* 0.0002 0.0140* 0.0004 Intercept 12.4059* 0.1696 13.5911* 2.6004 Wald (2,9) 584.02 Within 0.01 Between 0.20 Overall R2 0.10 0.08 Note: * significant at 1% level; ** significant at 5% level.

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Table 6

Competitive effects on generic price per country (generics only)

Canada coefficient SE t-value RP -0.063* 0.025729 -2.48 N -0.747* 0.053108 -14.07 N2 0.0202* 0.001498 13.52 N3 -0.0002* 1.32E-05 -13.02 Germany coefficient SE t-value RP -1.466* 0.032261 -45.46 N 0.0228 0.016379 1.4 N2 0.0005 0.000646 0.79 N3 9.71E-06 7.30E-06 1.33 Spain coefficient SE t-value RP -0.064* 0.025729 -2.48 N -0.747* 0.053108 -14.07 N2 0.020* 0.001498 13.52 N3 -0.0002* 1.32E-05 -13.02 France coefficient SE t-value RP 0.178* 0.0364 4.89 N -0.660* 0.063308 -10.43 N2 0.054* 0.006479 8.33 N3 -0.0014* 0.000189 -7.13 UK coefficient SE t-value N 1.82* 0.647178 2.81 N2 -0.188* 0.084467 -2.23 N3 0.0056** 0.003189 1.76 Italy coefficient SE t-value RP 0.357* 0.041505 8.62 N 0.500* 0.026886 18.63 N2 -0.026* 0.001318 -19.97 N3 0.0003* 1.68E-05 19.65 USA coefficient SE t-value N 0.0832 0.208036 0.4 N2 -0.003 0.006577 -0.51 N3 2.65E-05 5.32E-05 0.5

Note: * if significant at 1% level; ** if significant at 5% level.

50


Table 7

Diffusion effects per country (volume effect)

Canada coefficient SE t-value N -1.44987 1.636119 -0.89 N2 0.169429 0.150735 1.12 N3 -0.00488 0.003781 -1.29 Germany coefficient SE t-value N 0.510663 0.555178 0.92 N2 -0.01668 0.025493 -0.65 N3 0.000151 0.000315 0.48

Spain coefficient SE t-value N -0.42394* 0.16897 -2.51 N2 0.016737* 0.007633 2.19 N3 -0.00018** 9.13E-05 -2.01 France coefficient SE t-value N -0.12763 0.168155 -0.76 N2 -0.00297 0.017518 -0.17 N3 0.000321 0.000519 0.62

UK coefficient SE t-value N 0.629708** 0.320895 1.96 N2 -0.05847 0.038773 -1.51 N3 0.001489 0.00142 1.05 Italy Coefficient SE t-value N -2.22571* 0.175114 -12.71 N2 0.121829* 0.009142 13.33 N3 -0.00157* 0.000122 -12.91 USA Coefficient SE t-value N -0.50154* 0.031687 -15.83 N2 0.015522* 0.000997 15.57 N3 -0.00012* 8.00E-06 -15.37

Note: * if significant at 1% level; ** if significant at 5% level.

51


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Competition in Off-Patent Drug Markets: Issues, Regulation and Evidence · 2013-04-22 · Competition in off-patent drug markets Kanavos, Costa-Font, Seeley 1.1. Placing emphasis