Gray Markets for Pharmaceuticals

¶ … Pharmaceutical Gray Market on Operations and Strategies

The safety, security and prices of pharmaceuticals in the United States represent a fundamental national security interest. When essential drugs are unavailable or priced too high, the public's health is threatened and this is what is happening because of the pharmaceutical gray market. This paper reviews the relevant literature to determine how the pharmaceutical "gray market" affects the operations of pharmaceutical companies operating in the U.S. pharmaceutical market as well as strategies used by pharmaceutical companies to combat this issue. A summary of the research and important findings concerning these issues are provided in the conclusion.

Review and Discussion

Generally speaking, pharmaceuticals are enormously expensive to develop and bring to market (Kelly, 1999). According to Kelly, "The development of prescription pharmaceuticals requires costly and time-consuming research. After a product has been developed, it must undergo the rigorous approval process of the Food and Drug Administration (FDA)" (p. 10). The process typically requires more than a year-and-a-half to complete because the pharmaceuticals are subjected to rigorous testing to ensure they are safe and efficacious for their intended purposes (Kelly, 1999). Moreover, competition in the pharmaceutical industry is fierce and profitability elusive (Bender, 2004). Not surprisingly, the pharmaceutical industry is highly concerned about potential counterfeit and adulterated drugs, as well as their potential for misuse and abuse (Kelly, 1999). According to Chi (2009), "The World Health Organization declares fake medicines are a global problem. In the U.S., 5%-7% of pharmaceuticals bought and sold are believed to be counterfeit. Some drugs that have fallen prey to this practice include Prozac, Zantac, Viagra, and others" (p. 66).

Recent increases in the proliferation of pharmaceutical for non-medical purposes in the United States have generated growing concern about the sources of these drugs (Valdez & Sifaneck, 2008). In fact, for the past 30 years or so, there has been increasing concern in the international business community regarding so-called "gray marketing" or what it is also termed "parallel importation" of pharmaceutical (Chen, 2002). According to Chen, "The gray marketing or parallel importation arises where a marketer imports branded products from abroad and then diverts and sells them through unauthorized channels" (2002, p. 196).

It is important to note, though, that in contrast to black markets for counterfeit or stolen merchandise, gray markets are not regarded as being strictly illegal (Chen, 2002), but the pharmaceuticals may or may not be authentic (Chi, 2009; Foxman & Muehling, 2009). Nevertheless, gray markets typically involve authentic goods in terms of their manufacturing source; however, it is the distribution of these goods that is violative of the law (Chen, 2002). According to Chen, "The parallel importers arbitrage products in one country at a relatively low price, and then sell them to another country where the authorized distributor's price for the product is high" (2002, p. 197). An example of gray marketeering would be European Union pharmaceutical marketers that are restricted by regulated prices, creating a niche for gray marketers (Chen, 2002). In this regard, Chen advises that, "Estimates for the size of the gray market there range from two to ten percent of the total market for prescription medicines and are expected to grow in the future" (2002, p. 197). As a result, there is growing concern about whether the importation of gray market goods that have genuine trademarks should be regarded as trademark infringement (Chen, 2002).

Pharmaceuticals can also be diverted from their intended markets when pharmaceutical manufacturers allow institutional customers, including long-term care facilities and closed-door pharmacies, to purchase discounted drugs (Ukens, 2009). According to Ukens, "Closed-door pharmacies, which do not serve walk-in customers, then turn around and sell the products for a significant profit to entities not entitled to the discounts, such as community pharmacies" (2009, p. 23). The problem of diverted drugs to close-door pharmacies is much larger than many observers might believe. In this regard, Ukens emphasizes that, "It's estimated that between 50% and 80% of closed-door pharmacies participate in such diversion schemes. Some closed-door pharmacies are not really pharmacies at all but are established solely to purchase and resell discounted pharmaceuticals" (2009, p. 23). The gray market for pharmaceuticals is also fueled by "American goods shipped to charities overseas (although sometimes they never left the docks) and the resale of free prescription samples and medicines originally sold at sharply reduced rates to hospitals, nursing homes, and clinics" (Conlan, 2009, p. 33). There are other gray market sources as well. For instance, according to Chi (2009), "There are also storefront operators or shell companies that buy drugs at institutional prices, then sell them to retailers and quickly go out of business to escape being caught" (p. 66).

At first blush, this diversion of pharmaceuticals would appear to be a straightforward business matter, but there is a very real social problem associated with these practices. As Ukens points out, "Deep discounts, up to 99%, create a gray market-for drugs. Such diversion has been found to be an extensive enterprise affecting the safety, quality, cost, and availability of those products to consumers, thereby endangering the public health and welfare" (2009, p. 23). The diversion of pharmaceutical in this fashion adversely affects the costs and availability of pharmaceuticals in particular. For instance, Ukens reports that, "The most graphic recent example of the gray market at work was [the recent] influenza vaccine shortage. Hospitals and clinics couldn't get supplies through the normal distribution channels, but gray market distributors were able to obtain the vaccine and proceeded to push the price through the roof" (2009, p. 23). The conventional manner in which pharmacies and healthcare organizations typically receive their pharmaceuticals through primary wholesalers is depicted in Figure 1 below.

Figure 1. Conventional pharmaceutical distribution chain

Source: Tomsic, 2013

By contrast, some secondary wholesalers have taken advantage of drug shortages in various parts of the country to stockpile essential medicines and then sell them at inflated prices as depicted in Figure 2 below.

Figure 2. How the "gray market" interrupts the standard drug supply chain

Source: Tomsic, 2013

Although pharmacies are under contract to sell to various healthcare organizations, some pharmacies take advantage of drug shortages to exploit the system. For instance, according to Tomsic, "Some small pharmacies break their contracts and sell to secondary, or gray market. We've seen where a drug may be sold in the gray market five or six times in the course of a day" (2013, para. 3). Likewise, Cherici, McGinnis & Russell (2011) report that, "When critical medications are not available through hospitals' usual channels of distribution, unscrupulous gray market distributors [are] quick to jump in with supplies of these drugs that they are more than willing to sell to healthcare providers at exorbitant costs" (para. 3). The price for the pharmaceutical increases as it is handled by each of these secondary distributors, sometimes inflating the price as much as ten times the original amount (Tomsic, 2013). As can be seen in the process illustrated in Figure 2 above, pharmaceuticals may go through several intermediaries before ever reaching their final destination. In this regard, Tomsic reports that, "One wholesaler sells it to a second, then a third, and so on -- sometimes without the drugs actually changing hands. They're paper transactions used to jack up the price. The price can go up easily 20, 30, 40 times in a day!" (p.

The gray market also includes so-called "drug tourists"; these tourists are U.S. citizens that travel abroad, generally to Mexico but also to South America and even the Netherlands, to purchase legal pharmaceuticals for recreational purposes (Valdez & Sifaneck, 2008). In this regard, Conlan (2009) reports that, "Millions of people are buying what are advertised as bargain-rate prescription drugs from offshore Web sites. Countless others are visiting Mexico, where prescriptions are not required for most medicines and are easily obtained for controlled substances, including OxyContin" (p. 32). The "Mexican connection" is especially troublesome for policymakers because of their different laws and lower costs for pharmaceuticals. For example, according to Valdez and Sifaneck, "Drug tourism along the U.S.-Mexican border is driven by the inexpensive costs of these substances, legal access to drugs whose distribution is loosely controlled in Mexico, and the close physical proximity of Mexico to the United States" (2008, p. 880).

The purchase of pharmaceuticals is legal in Mexico when foreigners have a prescription from a Mexican physician or dentist and American citizens are allowed to bring a 3-month supply of an unlimited number of prescriptions back with them to the United States (Valdez & Sifaneck, 2008). Indeed, hundreds of thousands of American citizens live in close geographic proximity to Mexican border cities, making access to pharmaceuticals that much easier (Valdez & Sifaneck, 2008). In this regard, Valdez and Sifaneck report that, "The drugs are particularly accessible to prescription drug users in the southwestern United States, who live only a few hours away in Mexican border cities such as Nuevo Laredo, Tijuana (San Diego), Nogales (Tucson), Juarez (El Paso), and Matamoros (Brownsville)" (2008, p. 880).

The Prescription Drug Marketing Act (PDMA), Public Law 100-293, was enacted in 1988 to combat the gray market in pharmaceuticals (Conlan, 2009). The PDMA was passed in response to growing concerns over counterfeit pharmaceuticals in the United States. In this regard, Conlan advises that, "To a large degree, [the PDMA] was spurred by the discovery of two million birth control pills meant to look like G.D. Searle's Ovulen-21. However, they contained little or no estrogen" (2009, p. 33). The FDA's Web site states that the PDMA was enacted: (a) to ensure that drug products purchased by consumers are safe and effective, and (b) to avoid the unacceptable risk to American consumers from counterfeit, adulterated, misbranded, subpotent, or expired drugs (Prescription Drug Marketing Act of 1987, 2014). The FDA also reports that, "The legislation was necessary to increase safeguards in the drug distribution system to prevent the introduction and retail sale of substandard, ineffective, or counterfeit drugs" (Prescription Drug Marketing Act of 1987, 2014, para. 1).

Among the more salient provisions of the PDMA with respect to the gray market are the following:

Section 3. Reimportation. Section 801 (21 U.S.C. 381) is amended by redesignating subsection (d) as subsection (e) and by inserting after subsection (c) the following:

"(d)(1) Except as provided in paragraph (2), no drug subject to section 503(b) which is manufactured in a State and exported may be imported into the United States unless the drug is imported by the person who manufactured the drug.

"(2) The Secretary may authorize the importation of a drug the importation of which is prohibited by paragraph (1) if the drug is required for emergency medical care."

Section 4. Sales Restrictions. Section 503 (21 U.S.C. 353) is amended by adding at the end the following:

"(c)(1) No person may sell, purchase, or trade or offer to sell, purchase, or trade any drug sample. For purposes of this paragraph and subsection (d), the term 'drug sample' means a unit of a drug, subject to subsection (b),which is not intended to be sold and is intended to promote the sale of the drug. Nothing in this paragraph shall subject an officer or executive of a drug manufacturer or distributor to criminal liability solely because of a sale, purchase, trade, or offer to sell, purchase, or trade in violation of this paragraph by other employees of the manufacturer or distributor.

"(2) No person may sell, purchase, or trade, offer to sell, purchase, or trade, or counterfeit any coupon. For purposes of this paragraph, the term 'coupon' means a form which may be redeemed, at no cost or at a reduced cost, for a drug which is prescribed in accordance with section 503(b).

"(3)(A) No person may sell, purchase, or trade, or offer to sell, purchase, or trade, any drug

"(i) which is subject to subsection (b),and

"(ii)(I) which was purchased by a public or private hospital or other health care entity, or "(II) which was donated or supplied at a reduced price to a charitable organization described in section 501(c)(3) of the Internal Revenue Code of 1954.

Section 5. Distribution of Drug Samples. Section 503 (as amended by section 4 of this Act) is amended by adding at the end thereof the following:

"(d)(1) Except as provided in paragraphs (2) and (3), no representative of a drug manufacturer or distributor may distribute any drug sample.

Despite these and other provisions of the PDMA, the gray market for pharmaceuticals in the United States has ballooned to more than $2 billion in recent years (Conlan, 2009) and to between $20 and $48 billion worldwide (Chi, 2009). According to Conlan, "PDMA was meant to sweep away the murky gray market in diverted prescription drugs. But the law didn't get rid of the gray market entirely, and now the profit margins are even higher." (2009, p. 34). Moreover, the PDMA failed to address the problem with closed-door pharmacies. For instance, Conlan adds that, "An apparent loophole in FDA regulations implementing PDMA may have opened the way for closed-door pharmacies. It seems to allow entities that service nursing homes and long-term care patients to resell discounted drugs" (2009, p. 34).