Why Medicines in India Will Become More Affordable Only When Pharmacies Compete

While many agree that the prices of essential medicines in India are very high, few agree on measures to lower them.

(Photo: Vibhushita Singh/The Quint)

While many agree that the prices of essential medicines in India are far higher, few agree on the measures to lower them.

Nearly a decade has passed since India implemented price controls on essential medicines – using the 2013 Drug Price Control Order. These price controls were supposed to make medicines more affordable. Yet reports that firms spend thousands of crores on promoting essential medicines such as paracetamol, continue to raise questions about the affordability of medicines.

While many agree that the prices of many branded essential medicines in India are far higher than what the cost of production would justify, few agree on the reasons and the measures to lower them.

I argue that the main reason for high medicine prices is the lack of competition among pharmacies. Therefore, the best measure to lower prices is to let pharmacies compete without the All India Organization of Chemists and Druggists (AIOCD), the pharmacy trade association, telling them how (not) to compete.

The AIOCD has one objective – to lobby to maximise profits for pharmacies – and it goes about achieving this objective by enforcing a “margin raj” in the pharmaceutical industry.

Currently, the AIOCD demands a minimum of 30 percent trade margin on medicines. But it faces few constraints in the pursuit of this objective.

When the AIOCD demands a 30 percent or more margin, the pharmaceutical firms set wholesale and retail prices such that the minimum threshold for the margin is not breached. The pharmaceutical firms often go beyond the 30 percent margins to entice the pharmacies to sell more of their product.

Therefore, in the presence of the AIOCD 'margin raj,' promoting more competition among pharmaceutical firms, leads only to more revenues for pharmacies but retail prices remain the same.

Few Can Challenge the 'Margin Raj'

Pharmaceutical firms not only guarantee a minimum of 30 percent margins but also provide volume discounts to pharmacies that are hidden from the consumers.

These quantity discounts imply that the actual margins pharmacies receive are significantly higher in many cases. To give an example, suppose a pharmaceutical firm gives pharmacies one tablet free for purchasing one tablet of its paracetamol brand. This doubles the realised margin for the pharmacy. In markets where pharmaceutical firms compete more intensely, our research shows that the pharmacies receive greater volume discounts and, therefore, significantly higher trade margins.

Few can challenge the AIOCD’s margin raj. In 2013, when India was implementing price controls on a small number of medicines, the AIOCD punished pharmaceutical firms that refused to provide 30 percent margins by boycotting the sale of their products.

Such firms quickly formed a consensus and wrote letters to the AIOCD promising to allocate desired margins, maintaining that some pharmacies may wish to compete by offering price discounts.

The AIOCD, however, strongly discourages price competition among its members, which conflicts with its central objective of maintaining a minimum of 30 percent trade margin.

The margin raj of the AIOCD began in the early 1980s, as it went to war with the pharmaceutical firms, demanding higher trade margins through organised boycotts.

Initially, pharmaceutical firms resisted these demands and even complained to the competition authorities about illegal boycotts. A continued campaign by the AIOCD and ineffective competition authorities at the time led pharmaceutical firms to acquiesce to dramatic increases in retailer trade margins.

The guaranteed minimum trade margins for chemists have tripled from around 10 percent in the early 1980s to 30 percent today, despite the technological change that has lowered the cost of distribution and retail.

The AIOCD employs several controversial trade practices that ensure that competition in a local market remains low.

It acts as a gatekeeper granting entry to a small number of medicine brands to be sold in a district market, compiles and distributes price information on the permitted products to pharmacies in a bulletin, and threatens to boycott pharmaceutical firms or pharmacies that deviate from its rules.

Is This Price Control Legal?

The key question for the competition authorities in India is whether these practices are legal or not.

The AIOCD’s dominance and its vertical practices are reminiscent of the Sugar Institute, a trade association of sugar refiners in the United States during 1927-36, until the US Supreme Court ruled its practices illegal.

The Sugar Institute and 150 other trade associations operated in the 1920s, until mid-30s in the US as “open price associations” that promoted "open pricing” – the requirement that members offer no secret price discounts.

Some argued at the time that open price trade associations facilitate information exchange in the public interest.

Yet as their role in sustaining a collusive pricing regime became apparent, and the legal thinking caught up with the economic thought in the Sugar Institute case. It is no longer possible to find such open price associations in developed countries because they are illegal and antithetical to competition.

Therefore, if the competition authorities in India do not contain open price associations such as the AIOCD, prices will remain high.

If competition authorities and regulatory agencies adopt measures to stimulate competition among pharmaceutical firms without addressing the role of the AIOCD, they will increase pharmacy profits through higher retailer trade margins, as we have witnessed since the 1979 price control order, but consumer prices will still remain high.

To reiterate, pharmaceutical prices in India will be more competitive only when pharmacies begin to compete with each other.

It is unlikely to happen if the AIOCD itself does not comply with the competition law and does not face competition from independent pharmacy owners that do not wish to be members of the AIOCD.

What Can Be Done?

What can the competition and other regulatory authorities do?

First, they can begin by examining how competition law treats open price trade associations and buyer power in other jurisdictions.

It is very likely that competition law in India is similar, if not identical, to other jurisdictions that deem open price associations illegal. But the laws have not been tested, and India has not yet reached its 1936 moment, when open price trade associations were dismantled in the US.

Second, if open price associations continue to operate freely in India, then it is important to take other measures such as capping the trade margins at pre-1980 levels, before the AIOCD, IDMA, and OPPI began their mutually beneficial agreement giving rise to rapid increases, at 10 percent for regulated medicines and 12 percent for unregulated medicines.

Third, any pharmacy that does not wish to be restricted by the AIOCD’s anti-competitive open pricing regime should have the freedom to leave the organisation without the fear of boycott and disruption of its supplies.

Finally, the progressive members of the AIOCD, the hard-working, entrepreneurial, pharmacy owners should reflect on the actions of their trade association.

They need to deliberate whether as owners of pharmacies they want to enable this open pricing regime that prevents the modernisation and their long-term viability.

Pharmacy owners should be able to operate their pharmacies without the AIOCD telling them how (not) to compete.

(Ajay Bhaskarabhatla is an associate professor in the Department of Applied Economics, Erasmus School of Economics, Erasmus University Rotterdam. This is an opinion piece and the views expressed are the author's own. The Quint neither endorses nor is responsible for his reported views.)