On May 26, amid news reports about yet another closed-door meeting that the National Pharmaceutical Pricing Authority (NPPA) had had with unspecified stakeholders, we were reminded of an interesting press release that the Ministry of Chemicals and Fertilisers had issued in July 2021.
The release said that the government had invoked paragraph 19 of the Drug Price Control Order (DPCO) and capped the trade margin for drugs and medical equipment related to the treatment of COVID-19 at a stunningly high 70% of MRP. The release added that the government had instituted a similar cap on cancer related drugs in 2019.
(The trade margin is the difference between the manufacturers’ price billed to trade and the MRP.)
On the face of it, these decisions seem like welcome moves – but they raise certain important questions.
First off, does this really imply that the distribution margins are really that much higher than the manufacturer’s margins? If so, what does this portend for the future health of this sector?
Second, more broadly and in the interest of transparent decision-making and policy formulation, why has the government acted only on these drugs and medical equipment, but not others?
Third, what is the NPPA’s basis to target such a steep margin?
If we are to understand the logic behind the NPPA’s decision, the body should place market data on products, brands, prices and margins by geography in the public domain.
There is a deeper point, however. For a long time, the DPCO had stipulated that prices should not breach a ceiling, and based the ceiling on the costs of the pharmaceutical goods in question. In 2013, it replaced this cost-based approach with one based on market-pricing. Here, the ceiling was based on the average of all comparable drugs currently being sold in the market.
But both in the old model and the new model, capping margins has been a deeply incongruous idea.
In general, the current system of distribution margins is fundamentally flawed. Profits in this sector are unevenly distributed as a result of how distribution margins are currently regulated, and this creates perverse incentives with predictable consequences. Most of the profits are currently captured by distributors – not innovators or manufacturers. So manufacturers have no incentive to invest in manufacturing, quality standards or innovation, and this can only be bad news for the overall sector in the medium- to long-term.
‘Distributors are unionised and, more importantly, because they have the ability to hold manufacturers to ransom.’ Image: Pixabay
A more accurate description of pharmaceutical firms in this scenario is ‘brand owners’ that outsource the actual manufacturing of the drug(s) to contract manufacturers. Ultimately, quality suffers – to put it mildly.
To make matters worse, distributors today behave like a monopsony – i.e. they maintain substantial control on the market, to the extent that the community of distributors is like a single buyer.
This is partly because distributors are unionised and, more importantly, because they have the ability to hold manufacturers to ransom. (They are also not afraid to do so despite a number of orders from the Competition Commission of India.) In addition, they respond to their own economic incentives by pushing high-margin drugs onto unsuspecting and relatively ill-informed consumers.
As a result of this classic principal-agent problem, the system leaves many consumers materially worse off. Local pharmacies only exacerbate the problem when they replace brands that may have been recommended to consumer-patients with ones that they have been incentivised to sell. All this naturally leads to a loss of agency on part of the patients.
A relatively recent development has been the advent of online pharmacies, which are able to offer drugs at lower prices to consumers. Their reasons include jettisoning of brick-and-mortar operations, better funding and, possibly, predatory pricing. Their rise has led to a tussle between traditional incumbents of the pharmacy space and online sellers, who are understandably keen to disrupt the market.
But we assert that the cost of distribution is not relevant to the price of the product. For example, there is no good reason why different brands of the same chemical composition, Paraclitaxel, should sell vials at prices ranging from Rs 1,500 to Rs 2,100.
An even more relevant example, and one that more people are likely to understand, is that of paracetamol. The cost of distribution for paracetamol is the same regardless of the MRP of the brand in question. So it makes no sense to assume that a higher MRP product will impose higher distribution costs!
The concept of a ‘distribution margin’ is well-established in the FMCG and consumer durables sectors – and where it actually makes sense. But surely this concept is not applicable in the case of medicines?
This is borne out by the lived experiences of patients in other countries. In the UK, for example, the dispensing pharmacist gets a fixed price (about GBP 0.9) for each prescription dispensed. The cost of the prescription itself is fixed at about GBP 9 in the UK and EUR 10 in Germany.
Consider some analogies for a better handle on our argument. The price of a postage stamp is the same regardless of whether the envelope contains a cheque for a million dollars or a letter to a loved one. A Tata Nano pays the same toll to go from Mumbai and Pune on the expressway as does an imported Rolls Royce. And airlines charge all passengers in the same category the same price; it does not and cannot depend on each passenger’s net worth.
Why then should pharmaceutical products be any different?
The long-term feasibility of pharmaceutical firms ought to be a topic that greatly concerns all of us in India. For this reason, we must all consider the manner in which cost and profit-sharing is currently organised in the end-to-end supply chain of the pharmaceutical industry, including R&D, raw materials, manufacturing and distribution.
We do not advocate price control for products, especially given the terrible history of the licence- and quota-raj in India. In fact, we propose a completely different model – one in which the state can intervene on supply and distribution but not without rationalising trade margins.
Then again, we cannot begin a conversation about trade margins, and definitely not have a policy on it, without the NPPA publishing data on distribution costs. Merely tinkering at the margins on this issue will make it look like an annual charade. The NPPA needs to do better and get rid of this irrational rent-seeking behaviour.
Murali Neelakantan is a dual qualified (English solicitor and Indian advocate) lawyer. He was formerly the Global General Counsel at Cipla and Executive Director and Global General Counsel at Glenmark.
Ashish Kulkarni blogs at econforeverybody.com, and teaches courses in economics, finance and statistics at various universities.