Almost as soon as the Office of Fair Trading (OFT) had concluded its market study into medicines distribution, the European Commission launched a sector enquiry into the generic products, uniquely by dawn-raiding companies throughout Europe.

While both these investigations focus on very different aspects of the pharmaceutical industry, they reflect an increased interest on the part of the competition authorities in the industry. Indeed, earlier in the year the OFT had concluded its market study into the Pharmaceutical Price Regulation Scheme.

The scope of this article is to present the key findings in the OFT's medicine distribution market study.  In summary, the OFT did have some concerns but concluded that these ought to be best addressed by government and therefore does not propose to take any further enforcement action.

1.    Background
1.1    How did it come about?
Pfizer announced in September 2006 its decision to appoint an exclusive distributor (for an initial period) to deliver its products direct to pharmacies and dispensing doctors.  This direct to pharmacy (or "DTP") distribution model heralded a fundamental change in the distribution of pharmaceutical products by cutting the wholesalers out of the distribution chain.

As other manufacturers were also contemplating similar DTP schemes, this, perhaps unsurprisingly, caused numerous complaints. In fact, close to 500 complaints were received by the OFT and on April 4, 2007 it announced that it was launching a market study into the distribution of medicines rather than opening a Competition Act investigation into Pfizer or any other manufacturer. 
The pharmaceutical industry is no stranger to the OFT and it is a market with which most competition authorities are familiar, following a number of rounds of consolidation.   The OFT has considered the pharmaceutical industry in several merger  and Competition Act cases  and healthcare is one of the OFT's priority areas.  In 2005 it initiated a study into the Pharmaceutical Price Regulation Scheme (PPRS) regime which culminated in a report in February 2007.

1.2    What is a market study?
A market study is not an investigation into particular breaches of competition (i.e. restrictive agreements or abuse of market power), but an explorative general study of a market that, for whatever reasons, does not appear to working well for consumers.

The OFT then gathers and analyses information with a view to concluding whether there are any concerns and, if so, how these could be addressed through, for example:

  • recommendations to the Government or sector regulators;
  • enforcement action under the Competition Act, where a specific competition law breach has been found (or is suspected);
  • a reference to the Competition Commission (for an even more detailed analysis of particular features of the market);  or
  • negotiating undertakings in lieu of a market investigation reference to the Competition Commission. 

1.3    The OFT's reasons for conducting the market study
The OFT viewed a market study route as the most effective investigation route for principally three reasons. First, even though the majority of complaints related to the exclusive nature of Pfizer's deal with Unichem, launching a Competition Act investigation into Pfizer would not have fully addressed the effects stakeholders had identified (e.g. margins earned across the supply chain and service levels to pharmacies). 

Second, it would allow a market wider analysis of the competitive implications of DTP schemes and, in particular, the fact that other manufacturers were considering implementing DTP schemes. 

Third, it would allow the OFT to consider whether regulation (e.g. PPRS) affecting the sector could be amended to address any problems or whether it may in itself be a contributing factor to any competition problems.   
2.    The OFT's key findings
The OFT concluded with three main findings: (i) a risk of higher prices to the NHS, (ii) possibly lower service levels; and (iii) the potential for less competition in the long run. Each of these will be outlined below.

2.1    High risk of increase in costs to NHS of branded medicines
The OFT concludes that manufacturers have incentives to decrease the discounts offered and that there is a high risk that distribution changes will increase the price paid by pharmacies which, in turn, will lead to an increase in the price paid by the NHS for medicines.

Brand manufacturers will be able to decrease discounts for branded pharmaceutical products on the basis that demand is unlikely to fall even if prices increased substantially, as when a prescription is written by brand name the only competitor in that instance is parallel imports.

By contrast, wholesalers under the current model do not have the same ability to change prices because they are constrained by other full-line wholesalers. 

Finally, the OFT concludes that the current PPRS arrangements, including the arrangements used to monitor it, do not appear to offer sufficient protection against manufacturers decreasing pharmacy discounts and thereby increasing costs to the NHS as a result of DTP.

2.2    Possibility of lower service standards to patients
The OFT's second key finding was that exclusive distribution deals were likely to reduce service standards.  Moreover, DTP schemes would increase pharmacies' administrative burden in the long run if they have to deal with a number of DTP suppliers rather than a single full-line wholesaler.   

2.3    Long-term decline in competition
Finally, the OFT concludes that concentration at the wholesale level could increase significantly if the majority of manufacturers appointed the same exclusive wholesaler.  The OFT also identified a risk that a wholesaler could gain a significant share of the market and that even though the barriers of entry were not insurmountable, it was uncertain that they are sufficiently low to prevent further concentration which could lead to one wholesaler having significant market power. 

3.    Recommendations
Despite the various concerns, the OFT stopped short of proposing enforcement action.  Rather, it recommended that the concerns are best addressed through government action.  However, it does leave the door slightly ajar for further intervention, particularly if competition were to reduce significantly in the wholesaling sector through additional DTP arrangements.
3.1    Recommendation One: Mitigating Cost Increases
The OFT recommends that steps are taken to safeguard the NHS from cost increases which may occur due to likely decreases to pharmacy discounts.  It presents two options to achieve this:

3.1.1    Option 1: Reducing the list prices in the PPRS framework by an amount equivalent to the average discounts received by pharmacies.  
This proposal would remove the traditional 12.5% discount and reduce the list price under the PPRS to reflect that removal.  Consequently, the reimbursement price paid under the PPRS to pharmacies would be the price paid by pharmacies to either the manufacturers (under DTP) or the wholesaler (under the traditional model). 

This would require some consequential changes to the reimbursement system to ensure sufficient profit levels for pharmacies. This could be achieved either through a direct payment from Primary Care Organisations based on the number of prescriptions or adjustments to other established payment mechanisms.

3.1.2    Option 2: The second option is to seek manufacturer's agreement to offering a minimum discount on sales to pharmacies. 
Under this option an equivalent benchmark or discount would be introduced for DTP schemes similar to the 12.5% discount under the traditional wholesale model. 

The discount would be calculated by reference to the discounts earned by pharmacies under the traditional wholesale model and, as a result, the traditional wholesale model discount may need to be explicitly built into the PPRS. 

While the first option is the OFT's preferred outcome, it also recognises that the Department of Health is extremely experienced in renegotiating the PPRS terms and that there may be other options which would meet the same objective of safeguarding NHS costs and may be simpler to implement than its own recommendations. 

3.2    Recommendation Two: Minimum Service Levels
In order to counteract against a potential reduction in service standards to pharmacies, the OFT recommends that the government should seek agreement from the manufacturers as to the minimum service levels.  In this respect, it considers that the Department of Health, the Scottish Government and the Department of Health, Social Services and Public Safety Northern Ireland are best placed to set the appropriate minimum levels. 
4.    What does this mean for the Industry?
Despite some forceful language and conclusions (and a high level of press attention) the arena has been moved from the competition authorities to government.

The OFT has, in effect, cleared the new distribution model, subject to the invitation to government to re-jig the pricing mechanisms under the PPRS regime, leaving the door just a little ajar, in case the entire industry moves towards DTP.

This follows a somewhat familiar pattern.  In the PPRS market study the OFT concluded the PPRS system did not allow the NHS to obtain value for money in respect of its purchases of branded drugs, but that the government was best placed to replace the PPRS system with a more value based regime. 

The focus has now shifted towards Europe, following the Commission's launch of a sector enquiry into generic market entry, although it is too early to speculate about likely outcomes or themes.

John Schmidt is a partner and Dawn Hendry a solicitor specialising in competition law with UK law firm Shepherd and Wedderburn.

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