Parallel Trade: A Bigger Problem in a Bigger EU?

As the European Union gears itself up to welcome ten new countries in 2004, the pharmaceutical industry fears that parallel trade--already worth over 1 billion Euros ($.9 billion) a year--could increase. Some drug companies are trying to restrict supply to wholesalers, but legislation is likely to soon catch up.

As the European Union gears itself up to welcome ten new countries in 2004, the pharmaceuticals industry fears that parallel trade—already worth over €1 billion ($0.9 billion) a year—could increase. Some drug companies are trying to restrict supply to wholesalers, but legislation is likely to catch up soon

Now that most European Union countries use the same currency, the EU's next challenge is expansion to the East. But the drug industry isn't anxious to see such enlargement happen. All twelve candidates vying for membership have lower average drug prices than Europe's major markets. Yet the principle of free movement of goods throughout the EU means that when these countries join the European club, distributors will be allowed to export pharmaceuticals unhindered into the more lucrative Western markets.

In most parts of the developed world it's illegal to import drugs for resale. Yet the EU encourages parallel importers in the belief that parallel trade drives competition and brings prices down. The European Medicines Evaluation Agency's centralized drug authorization procedure now requires new products to have a single European brand name, and the newly introduced Euro means increased price transparency and less exchange rate risk, both of which make parallel importing a far easier game.

National governments, too, battling with the rising costs of public health care, are keen to keep drug prices down and support parallel trade by offering incentives to pharmacists. This is particularly true in Germany and the UK, which have some of the highest drug prices in Europe. In Germany, a law enacted last year requires that parallel imports account for 5.5% of pharmacists' turnover—rising to 7% next year. And pharmacists using cheaper imports make more money since they're reimbursed a fixed sum per prescription.

The situation is similar in the UK, where 90% of pharmacies use imports. But little of the savings in fact go back to the governments—the UK's "clawback" scheme requires pharmacies to return to the National Health Service only a fixed 9% of what they are paid per month for dispensing—leaving the (often considerable) extra margin coming from parallel trade to the middlemen, a point that the drug industry continues to underline in its criticism of the trade.

Parallel trade activity varies widely from one European country to the next, generally in inverse proportion to drug prices. Market penetration in France, therefore, is near zero, mainly because its drug prices are among Europe's lowest. In the Netherlands it's more like 15% (See Exhibit 1).

Reflecting the price differentials across Europe, parallel imports in the EU currently tend to follow a South-North channel, but "this could re-orientate with a raft of exports from the eastern side of Europe after accession," says Tim Frazer, a partner with law firm Arnold & Porter, which specialises in pharmaceutical intellectual property issues. An analysis by independent consultant Donald Macarthur shows that prices for branded products in central Europe (net of VAT and margins) are well below those of the major parallel import destinations Germany and the UK (See Exhibit 2).

The East-West parallel trade axis—if indeed it arises—is most likely to originate from the Czech Republic, Hungary and Poland, all of which have sizable domestic industries that largely adhere to EU production standards. Poland has seen substantial foreign investment into its industry: GlaxoSmithKline PLC put $218 million into Polfa Poznan SA in 1998 [See Deal]; Croatia's Pliva DD , itself now a highly westernised company, paid $100 million for a stake in the previously government-owned Polfa Krakow [See Deal] in 1997, the same year that Valeant Pharmaceuticals International Inc. paid the Polish government $33.7 million in cash for an 80% stake in Polfa Rzeszow [See Deal]. The situation is similar in Hungary.

The free trade principle prevents the EU from blocking the potential flood of exports from Eastern countries on the grounds of price. But companies may be able to at least temporarily stem the trade based on differences between the patent protection rules applicable in current and soon-to-be EU states, as occurred in 1986 when Spain and Portugal joined the EU. Because neither country had any patent protection covering pharmaceutical products at the time, parallel importers were forbidden to import patented products until December 1995, three years after Spain had made these patentable.

At first glance, the odds in favor of a similar transition period for Central and Eastern European candidates appear slim because they already offer patent protection. Nevertheless, in February the European Commission suggested a transitional period barring free movement of any product having any lesser degree of intellectual property protection in an accession country than it does at the time in a member state. Under this approach, some brands could have as much as ten years' protection against parallel imports sourced in the central and eastern European states. With enlargement, predicts Brendan Barnes, EU enlargement manager at the European Federation of Pharmaceutical Industries and Associations, patents will be used to stop parallel trade on a product-by-product basis. Which is the way the trade works currently: parallel importers cherry pick the branded products where demand is strongest and quickest profits can be made.

Still, given the ill-defined (what counts as "lesser" patent protection?) nature of EU attempts to prevent trade, as well as the Union's somewhat contradictory stance on the issue overall, drug firms have long searched for ways to bypass free trade laws. Enlargement will likely increase the use of such tactics. Bayer AG and GSK both found, after a number of attempts, legal routes by which to limit or block parallel trade of some of their products. Bayer in 1989 imposed quotas on supplies of its anti-hypertension drug nifedipine (Adalat) to Spanish wholesalers, citing "stock shortages." The company was fined €3 million after a Commission investigation. But the European Court of Justice (ECJ) overturned the decision on appeal, since Bayer had not officially imposed an export ban, nor had it produced an agreement with its wholesalers to limit parallel trade. As a result, Bayer had not strictly entered into an "anti-competitive agreement". "This decision appears to leave some scope for pharmaceutical companies to implement parallel trade prevention strategies; they can impose restrictions on wholesalers, or otherwise seek to prevent export" as long as the company doesn't have a dominant position, and there's no collusion between it and the wholesalers, explains Gavin Robert, a partner at London law firm Linklaters & Alliance. Robert predicts a range of responses, following the Adalat decision, from companies keen to limit losses to parallel trade.

Indeed, GSK—ordered to end its dual-pricing scheme in Spain in May 2001—last December sought to fit its export policy within the loophole opened by the Adalat judgement, telling the Commission it would restrict the amounts wholesalers can purchase. Others have followed suit this year: Sanofi-Synthélabo SA and Eli Lilly & Co. , as well as smaller players such as Boehringer Ingelheim GMBH , say they are restricting supplies to distributors.

The Adalat decision may offer only short-term relief. The European Commission is debating both GSK's revised scheme and is appealing the ECJ's decision to overturn the Bayer fine. But drug companies may have another option: removing or reducing the ex-manufacturer price differentials (the price differences when the products come out of the factory) of their products across the various EU states.

One way to do this, suggests Eckhard Kucher, PhD, president and managing director of consultancy Simon Kucher & Partners, is not to sell products in certain low-priced territories. "I would seriously consider," says Kucher "whether to sell my product in Greece," which accounts for just 1% of the EU market but, as the EU's lowest price market, is a major source of parallel imports.

Rather than explicitly restricting certain EU countries' access to drugs, some groups have instead sought to take away the incentive to parallel traders in the first place, through adopting a consistent European pricing policy and setting prices within a narrow band. Schering AG of Germany has been doing this since the early 90s, hoping that price differentials will not be sufficient to interest parallel traders. While Schering may forego full reimbursement in some states where the prices it demands are too high, the company reckons reduced levels of cheap imports more than compensate for this loss.

Schering's policy appears to have worked. One of the company's products, launched in 1985 before Schering instituted its pan-European pricing system, is priced, in its highest-priced market, at 2.4 times the price in its lowest-priced country. Parallel trade in this product takes €16 million off profits per year. Contrast this to a drug launched in 1995, after the policy was introduced. Its highest price is just 1.3 times its lowest and, so far, the drug is not parallel traded at all.

Harmonized European pricing isn't the answer for all drug firms, though. Schering can pursue this pricing policy because its specialist products aren't subject to the intense competition surrounding blockbusters. Provided Schering's products perform well overall, the company is prepared to accept lower sales volumes in some territories where the drugs cost more than competitors and as a result might be excluded from state reimbursement. In any case, many prescriptions in countries like Hungary are paid for out-of-pocket or with private insurance, so reimbursement through the state health service is not a prerequisite for profitability. Indeed, higher prices can work to the drug company's advantage: "Patients see a high price and believe it is an innovative and good product," says Michael Bohn, head of pricing policy at Schering.

Parallel trade may only account for about 2% (by retail value) of the totalEU drug market (or €1.25 billion), according to Klaus Hilleke, PhD, a senior partner at Simon Kucher & Partners, but the trade will continue to grow as long as the ex-manufacturer price of a product in one country is low enough to cover export and repackaging costs, and as long as pharmacists have reason to use the imports. Predicting when—and where—the trade will prosper isn't easy. Richard Freudenberg, managing director of UK importer Doncaster Pharmaceuticals Group Ltd., suggests there may even be exports from existing low-priced EU countries such as Greece and Portugal to eastern European states like Hungary and Poland where pricing is freer and branded products tend to be relatively more expensive—although still far cheaper than Germany and the UK. And if Freudenberg is right, drug firms that don't follow Schering in setting harmonized prices throughout should be hiring yet more lawyers.

— by Edwin Bailey, contributor