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The trade off

Is the EU brave enough to make radical policy change to tackle parallel trade?

Two business men about to shake handsIn the early 1990s I was working for an international pharma company. On my first ever visit to the UK affiliate I was warmly greeted by the general manager. However, upon hearing that I was the pricing manager within the global group his demeanour immediately changed. I was virtually pinned against the wall as I felt the full force of his anger. In effect he made me feel that I was not doing my job unless I lay in the road at the Dover docks to prevent the lorries bringing parallel traded products into the UK.

This was my baptism into the world of parallel trade; a world where emotions ride roughshod over rational arguments.

Parallel trade is the cruellest of all the ills, that afflict the industry in Europe, because a company's own products are used against it. Traders are able to take advantage of the free movement of goods, but the industry is not able to freely set its prices, so can do very little to prevent the practice.

The industry has cried that the losses due to trade will bring problems - affecting safety, causing shortages, allowing easier access to counterfeits and limiting the ability of the industry to afford R&D. Despite numerous lobbying tactics, these howls of protest have generally fallen on deaf ears.

Parallel trade is a complex business. To counter this 'demon' the industry has devised numerous strategies, based on legal rights and commercial tactics. These include the defence of intellectual property rights and trademarks and ensuring that other provisions, such as the specific mechanism relating to parallel imports from accession markets, are adhered to. Commercial tactics are more varied, with market segmentation, price corridors and launch sequencing, dual pricing in Spain, free pricing with rebates or brand equalisation, repackaging, direct distribution to allocation and supply management schemes.

Limited success
The strategies have had limited success, sometimes because they are strategically flawed. Tight price corridors are not easy to maintain in Europe. Other strategies have been legally challenged; dual pricing - which is a form of free pricing that has had some success in Spain, and sales allocation and supply management - which are based on sales quotas. Quota schemes have been established on specific products in certain countries by many companies. They have had a mixed legal reception, with the European Court of Justice (ECJ) seemingly reversing previously made opinions about their use. In 2005 Advocate General Jacobs in the Syfait case (a wholesaler) described quotas as a reasonable and proportionate measure in defence of that undertaking's commercial interests.

Whereas on April 1 this year, Advocate General Ruiz-Jarabo maintains that, a pharmaceutical company holding a dominant position which refuses to meet the orders of wholesalers, in order to limit parallel trade, engages in abusive practice.

Effective management
While we wait for the final judgement in pending ECJ cases, it is worthwhile to explore effective parallel trade management strategies. Quota systems work by limiting volume supplied to each wholesaler. This must involve no negotiation and be consistent for all equivalent wholesalers in the country concerned. Because it is impossible to forecast domestic demand with complete accuracy, a 'tolerance' is built into the allocation to allow for this uncertainty.

A quota scheme will not eliminate export from a country, but it will reduce the volume. Setting up a functional quota scheme requires significant work at the regional and affiliate level. There is a potential customer relations issue as wholesalers will be upset by having supplies limited. It is important to balance the cost of implementation and the expected gains. When applied correctly, sales allocation does reduce the level of parallel trade.

When establishing a sales quota,  consider the selection of countries. Closing parallel trade in one country might only lead to another becoming a target for traders. Which products will be subject to quotas also requires careful deliberation. The company must make a good estimate of domestic market needs and allow for growth and contingencies should they arise.

Careful consideration of any commercial interests is required. Companies must weigh the net impact of losses in importing countries and gains in exporting countries. A comprehensive analytical approach, which breaks the estimation down into steps, can simplify this and help ensure a comprehensive strategy. The analysis is improved considerably if several sources of secondary data are used. Often the data can also help identify the source market of the parallel trade, but import and export data rarely balance. The data often require careful application. The more countries considered, the more likely the complete picture will be understood. This will allow for a more accurate estimation of the impact of minimising exports from one country.

Accurate quotas
There can be severe consequences of miscalculating the sales quota. Under-estimating domestic demand can result in inability to supply domestic market. 'Stockouts' mean lost sales, they put patients at risk and result in a loss of goodwill in domestic markets. Over-estimating domestic demand leads to high parallel trade and unnecessary profit exposure. The objective is to strike the right balance, remembering that generally stockout is more damaging than excess parallel trade.

Supply quotas have some legal basis, but they only reduce the amount of stock available for export, they do not prevent all parallel trade. A quota system requires significant work and expertise to plan and implement. Most costs are hidden - such as staff time and loss of goodwill - so only implement when likely savings are substantial. Such schemes require both head office and local affiliate time, resources and - most importantly - commitment.

A growing concern
According to IMS, in 2007 parallel trade grew at a faster rate than branded products. However, the extent of the trade across Europe has been about 3 per cent for many years. If the trade is 3 per cent of sales, then the profit impact is about 1 per cent, since it is the company's own products that are being substituted.

One of the reasons that the European Commission (EC) supports parallel trade is to help bring about healthcare savings. In 1998 the Commission Communication on the Single Market in Pharmaceuticals stated that, Unless parallel trade can operate dynamically on prices, it creates inefficiencies because most, but not all, of the financial benefit accrues to the parallel trader rather than to the healthcare system or patient.

In most countries only a fraction of the margin difference actually finds its way in the health authority's or insurer's coffers. The majority of the margin goes into repackaging, distribution, license fees and of course, into the pockets of the parallel traders.

This is an extremely inefficient way to bring about savings. This leads me to my proposition; what if the entire European pharmaceutical industry were to offer every country in Europe a 1 per cent price cut in return for the EC banning parallel trade? Think of the benefits? The health authorities and insurers would capture a bigger saving than any they have achieved through parallel trade. Meanwhile, the industry could stop wasting valuable time and money on trying to counter trade.

It seems like a win-win situation. The only losers would be the parallel traders. Is the industry bold enough to make the offer and would the Commission be brave enough to allow such a change, to one of the EU's founding principles, for the sake of common sense?

The Author
Keiron Sparrowhawk
 is a partner at PriceSpective - ksparrowhawk@pricespective.com; www.pricespective.com

30th May 2008

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