Pharmaceutical parallel trade: An empirical study of Danish parallel distributors’ competitive behavior

Abstract

This study investigates pharmaceutical parallel trade, a practice whereby third party companies can legally import drugs under patent protection from one country, where they have been put into circulation by the patent owner, to another country, but without the consent of the patent owner. Pharmaceutical parallel trade is mainly the result of differences in pharmaceutical price regulation across the EU, which leads to substantial price differences. The study analyzes the competitive behavior of the firms undertaking parallel trade in Denmark, the so-called Parallel Distributors. It establishes these firms’ observed pricing behavior, and finds that parallel distributors on average price 8% below the original manufacturers. For several drugs, the price differences are, however, much smaller. Parallel distributors are also found to hold market power by being able to price above marginal costs. Next, the reasons for this behavior are investigated and the behavior is found to be the result of firms acting rationally in line with Industrial Organization theory. Parallel distributors’ pricing behavior is found to be the simple result of drugs being exposed to different degrees of fluctuating capacity constraints. For drugs exposed to severe capacity constraints, parallel distributors price close to original manufacturers, whereas drugs exposed to loose capacity constraints are characterized by higher price competition between the parallel distributors, leading to lower parallel distributor prices. Direct savings, meaning savings arising due to parallel distributors’ prices being lower than the original manufacturers’, do arise from parallel trade. These savings are, however, only significant for drugs being loosely capacity constrained. Furthermore, it is often argued that parallel trade puts downward pressure on original manufacturers’ prices, thus leading to additional, indirect savings. This study finds, however, that original manufacturers have few incentives to price compete with parallel distributors in Denmark due to international reference pricing and the original manufacturers’ incentive structures, which means that significant indirect savings do not arise. At the same time with savings from parallel trade being relatively small in Denmark, the pharmaceutical industry, which represents the most important export good for Denmark, may be severely hit by parallel trade on a global scale. Manufacturers care about global profits, and the presence of parallel trade combined with indirect savings in other countries mean that original manufacturers’ profits fall. The lost profits could have gone into research and development for new drugs. Due to the imbalance between costs and benefits from parallel trade in Denmark, this study recommends that Denmark works for modified restraints on or a ban of parallel trade.