Price Discrimination in Practice

Case 12.1: Price discrimination in Practice

1. Why do drug firms give discounts voluntarily?

Drug companies mainly offer discounts in the form of rebates. In a rebate arrangement, the purchaser buys the drugs at the list price, but the seller later refunds the purchaser the rebate amount (Stomberg, 2021). In most cases, the rebate amount is tied to the volume of drugs purchased, purchase loyalty, prompt payment, and increased breadth of purchases (Stomberg, 2021). Therefore, drug companies issue them as a means to encourage purchasers to buy higher volumes and to incentivize them to remain loyal (Stomberg, 2021). Thus, ultimately, drug companies voluntarily offer discounts to make more money and increase their market share from their high-end products.

Secondly, drug firms voluntarily offer discounts as a means to earn preferential treatment on the pharmaceutical formulary (Stomberg, 2021). A formulary is a list of preferred drugs developed using evidence-based medicine and the judgment of experts such as pharmacists and physicians (Stomberg, 2021). The formulary’s primary purpose is to encourage the use of effective, safe, and the most affordable medication as a means to improve or maintain quality care (Stomberg, 2021). By offering rebates, the manufacturer builds a relationship with purchasers, who can, in turn, use their influence to favour the manufacturer’s brand name over other competing brands. Preferential formulary listing thus provides a means for the manufacturer to increase higher revenues and increase its market share.

2. Why do the uninsured typically pay the highest price?

The idea of the uninsured paying more than their insured counterparts for drugs draws from the concept of price discrimination. Lee (2019) defines price discrimination as selling the same product or service to different consumers at different prices. Sources contend that the uninsured pay more for drugs than their insured counterparts (Alhabeeb & Moffit, 2012; Lee, 2019). The main reason for this is that the uninsured have low bargaining power over drug prices as compared to the federal government and insurance companies (Lee, 2019). The federal government and large insurance companies are able to use their large size to bargain for better prices for their beneficiaries (Cook, 2000). Conversely, uninsured persons may not have the capacity to bargain for better prices and do not have a body or agency that could negotiate the same on their behalf (Lee, 2019). Due to their low bargaining power, the uninsured are often forced to pay the list price as their insured counterparts pay much lower prices. Lee (2019), for instance, mentions that some organizations could negotiate for discounts of up to 60 percent of list prices for their beneficiaries.

The uninsured also pay more for drugs for their insured counterparts because of their low price elasticity. Price elasticity is a measure of how responsive a customer or customer group is to changes in prices (Alhabeeb & Moffit, 2012). Lee (2019) identifies differences in price elasticity as a pre-condition for price discrimination. As such, price discrimination is only possible between two customer groups if they have different price elasticity. Individual uninsured persons have low responsiveness to drug price changes. Although they pay for their medical expenses out-of-pocket, the uninsured are less responsive to price changes because they still have to incur the costs by themselves nonetheless despite the price change. Insurance companies, on the other hand, are highly price sensitive and have the power to shift from one brand or drug manufacturer to another in response to a price change (Alhabeeb & Moffit, 2012). Due to their low price elasticity, uninsured persons are less likely to respond immediately to price increases and even if one switches from a brand, the effect of the change is minimal. For this reason, the uninsured are exposed to higher drug prices than their insured counterparts.