Why the government wants to cap trade margins on drugs and why it shouldn’t

The abnormally high margin that trade channels are believed to earn on a relatively small portion of the Indian pharmaceutical market has become the latest painpoint for the central government. The  margins in question even cross 1000 per cent in some cases, according to a new report by a committee set up by the Department of Pharmaceuticals (DoP) in the Union Ministry of Chemicals and Fertilizers to investigate the matter.

The committee has now recommended capping trade margins on not just such meds which go by the moniker of ‘trade generics,’ but all drugs.

A cap on trade margins is not only difficult to implement but will do precious little to lower the price that the consumer pays. It might even lead to disputes and litigation between companies, trade, and the government. Besides, trade generics constitute not more than 15 per cent of the overall pharmaceutical market – and that is an outside estimate. Yet, this is being done in the name of the consumer.

What is the problem exactly?

First, let’s understand why such margins have come to be. One, higher trade margins encourage the retailer to switch a doctor-prescribed brand of a drug with a more lucrative brand (for him) even though the drug is the same and both have similar maximum retail price (MRP). Experts I spoke to say that this is a tactic used even by marquee drug companies to shore up share in specific drug categories in a competitive market such as a metro city. The higher margins are possible not because the price to consumer is hiked. Instead, the doctor promotion costs are saved and passed on to trade. Also, the marketer often sources the product economically from a contract manufacturer and refuses to take back expired or damaged goods.

It follows that capping margins will not have a bearing on the MRP. Rather, to stop this practice, perhaps the state food and drug administrations should crack down on illegal substitution by chemists of one brand with another.

Two, high margins incentivise the chemist to fulfil “non-prescription” demand, when the consumer approaches the chemist directly with minor ailments, with the margin-giver’s product. I would think that the more worrisome part here is the existence of such demand on a scale large enough for companies to turn it into a targeted segment.

Three, high margins help to capture the market for dispensing doctors. This, I think, is self-explanatory.

Reasons number two and three also drive sales of these so-called trade generics in smaller towns. Here, the doctor-patient ratio is lower than in cities so it follows that prescription-led demand would be lower also. But people still fall sick and need medicines. Fewer national companies are present here and their place is taken by bare-bones regional outfits operating on wafer-thin margins that source drugs from third-party manufacturers and sell them at low prices either to a small group of dispensing doctors, or to a trade channel or even to doctors operating pharmacies. In some cases, companies might offer attractive bonus schemes.

Here, the trade is being incentivised to create access points for drugs that would otherwise not exist. If some of them end up profiteering from it, well, this is the price you pay for decades of healthcare neglect.

For the most part, logic suggests that the price to consumer still has to be what the market can bear even where there is less choice. Or hospitals in small towns would have routinely charged more for tests and procedures than comparable ones in cities, right?

Assume that is not the case.  Assume that this is entirely driven by greed and the need to gain market share at any cost. The National Pharmaceutical Pricing Authority (NPPA) already has the power to intervene in public interest under India’s drug pricing policy by fixing a ceiling on MRP of drugs in public interest whether or not the drug is a so-called ‘scheduled drug,’ which means a drug under price control. For that it needs, not new rules, but robust market intelligence and surveillance tools -maybe even more feet on ground.

Will margin caps impact prices?

There is no evidence to prove that the business model of trade generics, an over-a decade-old practice, has led to across-the-board price increases. If that is the case, this issue should have been tackled by the Drug Prices Control Order, 2013 which was 12 years in the making.

From the consumer’s perspective, I see two concerns involving the business model of trade generics. One is if this practice is incentivising unscrupulous traders to push poor quality or irrational drugs into the market. And two, like I said earlier, if it is abetting the over-the-counter sale of prescription drugs. The solution then is for the central drugs regulator and the state food and drug administrations to tighten oversight.

But the commitee thinks the problem is profiteering and the “fleecing” of consumers. The margins are making an impact on MRP, it says.  “In some cases, the price of trade generics are even more than their branded generic (meaning doctor-prescribed) equivalents,” the report says.

But it stops short of putting a number on the extent of the problem. It relies instead on overall sales of the trade generics market provided by various stakeholders. These range from 6 to 15 per cent of the total pharma market. But is it in one per cent or 100 hundred per cent of the trade generics market that the consumer is being fleeced? The short answer is : they don’t know. So they decide that perhaps it is better to just cap margins for all drugs.

Now, assume that margins are capped. How will the DoP ensure compliance? The NPPA already has its hands full with price controls on a basket of over 300 drugs where price ceilings are fixed by averaging the MRP of the top three brands of a drug. It has had to virtually theaten pharma companies to register with a new government database so that it can keep tabs on these prices.

Creating new margin caps only makes its task more complicated. To top it all, the committee has recommended a range for maximum allowable trade margins from 35 to 50 per cent depending on the price per unit of consumption (i.e.tablet, capsule, bottle etc). The slicing and dicing this calls for would put a Masterchef to shame.

While the government should be concerned with affordability, capping trade margins is not going to achieve that end. Rather, it will mean getting embroiled in the minutiae of who is making how much and use up precious time and resources better spent on potentially more impactful things like, say, streamlining and expanding Jan Aushadhi, the Centre’s affordable drug retail outlets.  A section of the drug industry has even argued that high trade margins make it attractive to sell drugs in smaller markets and that capping them will have a direct impact on supplies. Besides, ingenious entrepreneurs will find ways to circumvent the cap.

Given the limited resources of our regulators, isn’t it better to look at tools that can achieve the greatest good of the greatest number on a sustainable basis? Margin caps are not sustainable and nor is it clear whether they will make a difference to the consumer’s healthcare expenses.

Having raised the issue, the DoP cannot simply walk away from it. So this could end in one of four possible ways. One, the industry agrees to a compromise or palliative such as a voluntary cap that it has no real intention or ability to implement. Two, the government puts off a decision. Three, the cap is fixed in letter but execution is weak. Three, the government enforces the cap and ends up in court.  My bet is on number two.

Why? Because the report has already left open a rather large escape hatch. See my tweet below.



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