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Parallel lines

There is a long and unhappy history of litigation between pharma and parallel traders

Man hitting a dam with a malletWhen your legal department told you that you couldn't do anything to reduce the impact of parallel trade on your brand, they couldn't have been wrong could they?

There is a long and unhappy history of litigation between manufacturers of pharmaceuticals and parallel traders in Europe. In 1992 the free movement of goods and services was heralded across the EU and the Articles of the Treaty of Rome (1957) were formally applied on a pan-European basis. Since then the money to be made in trading on the different prices for medicines across Europe has attracted some of the most adept commercial minds. The battle lines are drawn between manufacturers and traders as each seeks to reap the margins available in countries with higher prices and fights with the vagaries of the Euro–sterling exchange rate.

Limiting supplies
The recent ruling by the European Court of Justice (ECJ) – with regard to GlaxoSmithKline's (GSK's) refusal, in 2000, to fill orders from Greek wholesalers beyond what it considered to be for domestic consumption – asks more questions than it answers. It is, however, an addition to the increasing body of law that demonstrates that manufacturers can act to protect their legitimate commercial interests. It also introduces the concept of 'intra-brand' competition.

The case, as is so often the way with European legal matters, is fiercely complicated and the number of conflicting decisions from different courts and Advocates General along the way is somewhat bewildering.

A little history may shed some light.

The Treaty of Rome: Edited Highlights
• Article 81(1): Prohibits any agreement, decision or concerted practice which has the object of the restriction of competition between member states of the EU.

• Article 81(3): Provides exemptions to Article 81(1) if the agreement, decision or concerted practice contributes to improving the production of goods or economic progress while allowing consumers a fair share of the resulting benefit without allowing the parties to eliminate competition.

• Article 82: Prohibits a company in a dominant position from taking any action which results in an abuse of its dominant position.

The standard precedent on article 81(1) is Bayer's case from 2000. The Court of First Instance (CFI) found that Bayer's action to limit supplies of Adalat to Spanish and French wholesalers (who were exporting to the UK) was not a breach of Article 81(1) because it was a unilateral decision by Bayer, without the agreement of the wholesalers, and so did not constitute a concerted practice.

Dual pricing
In 2005 the European Commission prohibited GSK from using conditions of sale in Spain to, in effect, run a dual pricing system with Spanish wholesalers by charging a higher price for products that were to be exported. GSK appealed to the CFI arguing that the normal rules of supply and demand did not apply to the pharmaceutical market where prices are often determined by national health authorities in the member states. The CFI did not accept this saying that parallel trade permitted a "limited but real reduction" in the price of medicines and so GSK's conditions of sale could diminish the welfare of end consumers and were a breach of Article 81(1).

No doubt dazzled by this bizarre conclusion GSK produced an ingenious defence, the so called 'efficiency theory'. This, in essence, says that parallel trade reduces the profit we, as researchers and developers of new treatments, can make from the sale of our medicines in those markets that will pay a higher price for them. This in turn reduces our 'efficiency' by reducing our capacity to innovate. The dual pricing system limits parallel trade, improves our efficiency and thus a share of the benefits accrues to the end consumer (in improved healthcare). The conditions of sale are therefore exempt from the provisions of Article 81(1) by reason of Article 81(3).

The CFI blew out its cheeks, basically said "well, you might have a point there" and referred the case back to the Commission for "further consideration".

Quota system
The first incarnation of the recent case came in 2006 when GSK's quota system in Greece was challenged under Article 82 as being an abuse of a dominant position. Although the question was never actually resolved by the court the Advocate General (Francis Jacobs at the time) provided an opinion which accepted GSK's efficiency theory argument and that pharma presents a special case because governments set prices.

The case then came back to the ECJ after a Greek court filed 11 references asking it to rule on a variety of issues. Another Advocate General, Ruiz-Jarabo Colomer, gave a further opinion which completely diverged from that of Jacobs. He suggested that special conditions in the pharma market did not justify the quota system and that the "efficiency defence" did not apply.

Out of the ordinary
The scene was therefore set for the ECJ to deliver the judgement it reached on September 16, 2008. The court accepted Advocate General Colomer's opinion that there was no special case for pharmaceuticals and rejected the efficiency defence. Despite this it went on to find that:
"It is permissible for that company to counter in a reasonable and proportionate way the threat to its own commercial interests potentially posed by the activities of [a wholesaler] which wishes to be supplied [...] with significant quantities of products that are essentially destined for parallel imports."

The deciding factor is whether the orders placed by the Greek wholesalers are "out of the ordinary" and the case was sent back to the Greek court to decide what actually constitutes 'ordinary.'

Supply and demand
The ECJ then went on to discuss what is, potentially, the most interesting part of their judgement. In rejecting GSK's argument that true price competition does not operate because prices are set by governments, the court found that, irrespective of price control, companies are actively involved in setting prices at a national level – in the internal national markets the company is free to actively compete to meet the demand for its patented brand. This 'intra-brand' competition seems to be at the heart of the court's analysis of how parallel trade derives some benefit to consumers.

So if your legal department tells you that you cannot compete with parallel trade in your market, they are out of line with how the ECJ believes the market should behave. When a doctor prescribes a product and the patient presents that prescription to the pharmacist this generates a demand for that product. The market to meet the demand for that product consists of product originally supplied in that market or product sourced from an overseas market.

The overseas product must be sourced, shipped, repackaged and distributed. In this process the product will pass through a minimum of three elements in the supply chain before it reaches the pharmacy; each of these will add their own margin.

Trading on trust
Yet some products have up to 80 per cent parallel trade despite the fact that the manufacturer has the advantages of original home-market packaging, guarantee of supply and is free to compete with the importers. Why? The answer is hardly difficult. After years of litigation between traders and manufacturers, if a manufacturer comes to talk to a trader about sourcing product in the home market rather than from overseas then the trader is unlikely to greet this approach with sympathetic ears.

The level of distrust between traders and manufacturers is unlikely to be diminished and win-win solutions are often undermined by the opportunity for traders to take lower-priced stock from the manufacturer and also continue to import regardless. There are many such attempts lying in tatters on the traders' stockroom floors.

Some believe that direct to pharmacy (DTP) schemes can help to compete in-market with parallel trade. None of the schemes introduced so far has had such an impact and, oddly, the wholesale partners selected for these schemes were, and remain, the biggest cross-border traders in Europe.

Some manufacturers have managed to combine quota systems and in market competition to reduce parallel trade to, what the ECJ would no doubt term, 'reasonable' levels. These companies realise that, if they hope to impact on this ubiquitous and fascinating market, they must match the range of products and surety of supply being offered to importers by full-line wholesalers overseas.

The Author:
Chris Doyle is a consultant at Unique Solutions for Pharma

4th November 2008


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