Pharmaceutical Pricing, Branding and Distribution - Competition Law Dos and Don'ts

1.    Introduction
Competition law seeks to promote welfare through economic efficiency.  In particular, it seeks to prevent harmful restrictive agreements and the abuse of monopoly power.  However, competition law cannot be applied in a vacuum.  The decision of what is and what is not efficient depends to a large extent on the market context. 

12 November 2007

1.    Introduction
Competition law seeks to promote welfare through economic efficiency.  In particular, it seeks to prevent harmful restrictive agreements and the abuse of monopoly power.  However, competition law cannot be applied in a vacuum.  The decision of what is and what is not efficient depends to a large extent on the market context. 

No more is this true than in the pharmaceutical sector where tensions sometimes exist between different areas of the law.  For example, intellectual property law and, in particular that patent system, seeks to reward and encourage innovation by rewarding the innovator with a legitimate but temporary monopoly position.  On the other hand, competition law seeks to enhance competition and curtail harmful effects of monopoly power. In addition, countries provide for an additional regulatory overlay whereby the state or state bodies take some degree of influence over the way pharmaceutical companies can maximise their commercial behaviour, for example how they price their products or how much overall profit can be made.

While media-grabbing cartels such as the current investigation of BA's fuel surcharges receive a predominant amount of attention, other aspects of competition law have the potential to impact on everyday commercial agreements. The key focus of this article is to discuss some of these areas in more detail. 

2.    Dealings with or against competitors
The key provisions in this context are the rules on restrictive agreements[1].   Not all restrictive agreements are treated in the same way.  Some agreements fall within pre-defined parameters and are justifiable and therefore exempt from prohibition on restrictive agreements.  Some are not justifiable but are unlikely to see any sanction beyond the invalidity of the contract, while some are sufficiently hardcore that they potentially attract significant fines or even criminal sanctions for the individuals involved.[2]

2.1    Hardcore Cartels
Agreeing with existing competitors the prices to be charged, discounts to be offered or the companies' bidding behaviour constitute the most serious breaches of competition laws.  Similarly agreeing with existing or potential competitors particular territories or customers that they may serve constitutes a hardcore breach.

Exchanging information on any of the above, or indeed anything that is commercially sensitive, is likely to constitute a breach in its own right or can be seen as a mechanism to monitor a price fixing, bid-rigging or market sharing agreement.

2.2    Research and Development
Joint R&D is sometimes contemplated in order to combine particular complementary strengths, technology or specialisms.  Sometimes joint R&D is contemplated in order to minimise risks through diversification of efforts. Sometimes it allows projects to be undertaken which either party could not undertake on its own.

The competition assessment for such agreements will by necessity be very specific to the case and largely driven by the market and factual context in which the agreement is contemplated.

An agreement is generally likely to give rise to competition issues, where the purpose of agreement is essentially to prevent two competing products from arriving on the market or if in some way it could be seen as delaying innovation in the market.  By contrast, agreements whose purpose is to facilitate more speedy innovation or bring better or more products onto the market are more likely to withstand competition scrutiny.

Clearly, the parties' size, market share and resources are an important factor in the assessment, as are the actual restrictions in the agreement.  For example, if parties are able to exploit the results independently this is seen as generally pro-competitive as it prevents the collaboration from extending into the underlying product market.  By contrast, where the exploitation of the results is joint, additional hurdles will have to be overcome.  Preventing parties from conducting their own independent research would generally give rise to issues, as would restrictions that sought to limit sales (other than solicited sales) into other territories.

2.3    (Cross-)Licensing
Licensing of technology between competitors can give rise to issues where the parties are particularly close competitors.  In assessing the impact, one has to distinguish between (i) the technology market (i.e. technology to be licensed) and (ii) the underlying product market.

An automatic exemption [3] exists where the parties' combined market share on both technology and underlying market falls below 20% provided that there are no hard-core restrictions and subject to some other detailed requirements such as duration of exclusivity provisions.

Where the automatic exemption is not available, exclusivity provisions, non-compete clauses, sales or territorial restrictions and field of use restrictions require a more detailed, individual examination.

Licenses forming part of settlement agreements (either in the run up to litigation or in the process of litigation) are not automatically exempt from the provisions of competition laws.  Where the agreement 'unblocks' a one-way or two-way blocking position, the arrangement as such will be regarded as generally pro-competitive.  In that case it is important to ensure that it does not contain restrictions that go beyond what is required to achieve such a position.  Reciprocal running royalties or entitlement to use the other party's future innovations may cause particular issues as these may reduce future competition between the parties, rather than allowing each of them to compete with each other.

In the US, settlement agreements, particularly between originator and generics manufacturers, have on occasion given rise to issues where the effect of the settlement was to delay generic entry.  In Europe this has so far not caused intervention by authorities, but it is possible that authorities may intervene where the settlement may lead to delayed entry.

2.4    Co-marketing/Co-promotion agreements
These types of agreement are a uniquely common form of co-operation to the pharmaceutical sector.  The extent to which they tend to give rise to competition concerns depends largely on how closely the parties already compete with each other (e.g. if they have identical products or complementary products) and with third parties (e.g. are they encountering a dominant incumbent or are they, or one of them, dominant). 

The competition analysis will also look at the economic benefits of the agreements as balanced against the potential downsides.  Where the arrangement is likely to reduce competition between the products or lead to an alignment of key competitive parameters (such as prices, customers or markets) they are unlikely to be justifiable. In certain circumstances they could be seen as drifting into the hardcore arena.

2.5    Gaming the system to prevent (generic) entry
With the prospect of generics entry at the expiry of a particular patent (and a consequent rapid fall in sales and market share), brand originators might want to protect its exclusivity in the market by deploying all procedural tools that lead to extended patent protections.

Making misleading representations to patent authorities in order to secure a supplementary protection certificate has been held to breach EC competition law (and which led to the imposition of a €60m fine)[4],  where this formed part of a carefully designed strategy to prevent generic entry. 

The issue is not, however, confined to misleading statements but can apply to any form of aggressive "procedural gaming".  In the same case, the European Commission decided that handing back marketing authorisations for particular products in order to prevent, or at least hinder, generic entry similarly breached competition law.   While the same process may no longer be available following changes to marketing authorisation rules, the case demonstrates a willingness on the part of the Commission to pursue over-aggressive use of procedural devices.

3.    Dealing with customers: pricing
In the absence of hardcore restrictions companies are essentially free to price their products or to design their discounts in any way they see fit.  There are two principal exceptions: first, resale price maintenance and, second, pricing practices where a company holds a position of dominance (fidelity rebates, brand equalisation and predation).  Each of these two situations is discussed below.

Aside:  When is a company dominant?  Broadly, once a company achieves a share of 40% dominance issues may become relevant.  However, absolute market share is only one factor.  Other relevant factors include the size of competitors and their share, the size of customers and their purchasing power and regulatory restrictions on competitors. 

3.1    Resale Price Maintenance
While manufacturers are free to recommend prices at which their products may be resold, attempts at imposing binding minimum resale prices constitute hardcore breaches of competition laws, irrespective of whether or not the supplier is in a dominant position.  The same applies to the situation where a supplier intends to achieve indirectly compliance with a recommended or guide price (e.g. through reductions of supplies or otherwise imposing more disadvantageous sales conditions).

While generally maximum prices are not objectionable, competition issues could arise in cases where the supplier is dominant.

3.2    Fidelity Rebates
A long line of old and new European case law [5] establishes the general principle that dominant companies cannot impose discounts and rebates which are loyalty enhancing.  Importantly, please remember that this only applies to companies that are dominant in relation to the product in question. 

Discounts which are purely based on volumes and which reflect economies of scale are likely to be acceptable.  By contrast, discounts which push the purchaser to purchase all or most of its requirements from the dominant companies may not (as it will foreclose competitors' access to that customer).  For this, it will make no difference whether the discount is made available in return for a contractual exclusivity or whether the targets are set at such a level that the relationship will de facto be an exclusive or near-exclusive one.  

The foreclosing effect will be particularly strong (which in turn drives the gravity of the competition issue) where targets need to be achieved over long reference periods, where they tie a dominant product with non-dominant products or where they target a top-slice of particularly contestable  supplies.

While it is easy to advise dominant companies only to offer volume related discounts, establishing when a discount is purely efficiency based and when it has a loyalty enhancing effect is rarely straightforward. 

3.3    Brand Equalisation
In a pharmaceutical context, brand equalisation schemes operated by dominant companies can be particularly problematic as they comprise elements of loyalty discounting, full line forcing and tying of contestable and non-contestable sales. 
Brand equalisation covers the practice where the supplier of a branded product, for which a generic version is available, provides a discounted, blended rate on the condition that the customer purchases all its requirements, generic and branded from the same supplier.  Typically, UK pharmacies will only be able to dispense generics if the prescription uses the generic rather than the brand name.  As a consequence, pharmacies tend to have requirements both for the branded products which are not to be contestable and for generics scripts which tend to be contestable.

While the OFT did not identify any particular concern with brand equalisation schemes in its recent market study in relation to the Pharmaceutical Price Regulation Scheme [6], that is not to say that it would not take a different view in a live case.  Nor does it mean that courts would take a similar view were the issue to come to the fore in litigation.

3.4    Predatory Pricing
Pricing below cost can give rise to significant issue where the company is dominant as, again, the effect is likely to force smaller competitors out of the market.  Essentially, pricing is generally viewed as predatory and in breach of competition law where:

  • A company prices below variable costs (i.e. costs which vary with output, such as raw materials); or
  • A company prices above AVC but below total costs together with an intention to eliminate a competitor. [7]

While it is often not straightforward to determine whether a price is below cost, where a dominant company intends to follow a deliberate strategy of low pricing in order to foreclose access it should tread with great care as the dividing line between compliance and breach may be very thin.  Moreover, internal documents that can prove the existence of a predation strategy are potentially discoverable by the OFT and by private litigants in court proceedings.

4.    Dealing with customers: restricting parallel Imports
It is relatively settled and well understood in the pharmaceutical industry that there are very limited circumstances in which parallel imports can be prevented using either express contractual exportation prohibitions or intellectual property rights.

Express export bans fall within the rules dealing with restrictive agreements, [8]  but only if they are based on an agreement between supplier and customer (which could be informal or even verbal).  Unilateral conduct (e.g. refusals to supply not based on a contract) can breach competition rules only if (i) the company is in a dominant position and (ii) such behaviour can be classed as an abuse. [9]

The following sections look at supply quotas or dual pricing practices against the background of whether they fall within either the rules on restrictive agreements or the rules on abuse of dominance.

4.1    Supply Quotas
The European Court of First Instance has held that a quota allocation system unilaterally imposed by a supplier does not fall within the restrictive agreement rules. [10] The case concerned Bayer's distribution policy to reduce supplies of its product Adalat to its Spanish and French wholesalers to levels that would cover only the amount needed for local use.  The aim was to prevent or reduce parallel exports into other, higher priced, countries.

The court was clear that such unilateral conduct does not become an agreement, simply because the purchaser does not terminate its commercial relationship out of protest.  This was confirmed on appeal. [11]  As a result, it might be possible to use supply quotas if (i) they are imposed unilaterally and are not incorporated into a contract (either at the outset or upon renewal of a supply contract); and (ii) the company imposing the quota is not dominant. 

However, in a situation where the supplier's product benefits from patent protection it will often not be easy to exclude the possibility that the supplier could be regarded as dominant. 

While there is some limited judicial support [12] for the proposition that unilateral supply management systems that limit sales to wholesalers to their domestic market requirements did not per se constitute an abuse of a dominant position, the position is still unsettled.  The court refused to rule on a technicality in that case leaving the Advocate General's opinion in somewhat of a limbo. However, the European court will have a further opportunity to clarify that position as the same case (minus the technicality) is again before the court. [13]  It may be hoped that the European court takes this opportunity to rule on the merits and provide much needed clarification.

4.2    Dual Pricing
Despite the noticeable trend towards allowing (unilateral) supply quotas (at least in the pharmaceutical industry), the position as to whether the same result can be achieved through dual pricing regimes [14] is significantly less clear.

The reason for this principally lies in the fact that supply quotas can be imposed unilaterally, while dual pricing regimes will inevitably be based on an agreement.  Therefore, dual pricing regimes would fall to be assessed under the much more restrictive rules on restrictive agreements.

The European Commission's traditional view is that dual pricing systems excluded or restricted the parallel trade in pharmaceuticals and that this could not be justified by any special circumstance of the pharmaceutical industry.  [15] GSK, which sought to introduce the regime, argued that the national pricing systems meant that parallel trade did not benefit the consumer but only shifted profits from the GSK to parallel traders and, in turn, seriously affected GSK's R&D budget.

On appeal, the Court of First Instance rejected the Commission's view that, given the restrictive effect of such a dual pricing regime, this constituted, automatically, an unjustifiable breach of the restrictive agreement rules.  Rather, any evaluation ought to look at the specifics of each case and the European Commission had failed to do so. 
On its own, the ruling provides insufficient comfort or certainty on dual pricing regimes.  A further appeal by both GSK (appealing the finding that the regime has a restrictive effect) and by the Commission (appealing the finding that it should have conducted an individual examination of the potential benefits) is still outstanding. 
Given the courts’ tentatively critical approach to previously established principles, it may be hoped that Europe's highest court takes the opportunity in this case to establish (or restate) the ground rules for dealing with parallel trade in pharmaceuticals. [16]

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

[1] Article 81 of the EC Treaty and Chapter I of the Competition Act 1998.  Other member states have similar provisions
[2] For example, in the UK BA was recently fined for £121.5 million by the UK's Office of Fair Trading for its involvement in fixing fuel surcharges on flights
[3] Technology Transfer Block Exemption Regulation 772/2004
[4] Case COMP/37.507 - Generics/Astra Zeneca.  The case is under appeal to the Court of the First Instance Case T-321/05, AstraZeneca v Commission
[5] Case 85/76 Hoffman-La Roche & Co AG v Commission [1979] ECR 461, Case 322/81 Michelin v Commission [1983] ECR 3461 and more recently, Case C-95/04 British Airways plc v Commission [2007] 4 C.M.L.R. 22
[6] The Pharmaceutical Price Regulation Scheme:  An OFT market study;
[7] Case C-62/86 AKZO v Commission [1991] ECR I-3359
[8] Article 81 EC and Chapter I Competition Act 1998
[9] Article 82 EC and Chapter II Competition Act 1998
[10] Case T-41/96 Bayer AG v Commission , 26th October 2000
[11] Cases C-2/01P and C-3/01P, Bundesverband der Arzneimittel-Importeure and Commission of the European Communities v Bayer AG, 6 January 2004
[12] See Advocate General Jacobs in Case C53/03 Syfait and others v. Glaxo Smithkline and others, 31 May 2005
[13] C-468/06 Sot. Lelos Kai Sia E.E. and others v GlaxoSmithKline
[14] Dual pricing regimes charge different prices to the same customer: a lower price for domestic requirements and a higher export price for volumes that are likely to be exported
[15] Case IV/36.997/F3 - Glaxo Wellcome +3 - Commission decision of 8 May 2001
[16] Case C-501/06, GlaxoSmithKline v Commission and Case C-513/06, Commission v GlaxosmithKline