Pharmaceutical Gray Market: Impact on Operations and Strategy

Introduction

The safety, security, and pricing 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 precisely 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 in the United States, as well as the strategies used by those companies to combat this issue. A summary of the research and important findings is provided in the conclusion.

Understanding the Pharmaceutical Gray Market

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 pharmaceuticals are subjected to rigorous testing to ensure they are safe and effective 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 pharmaceuticals 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," also termed "parallel importation," of pharmaceuticals (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 that, in contrast to black markets for counterfeit or stolen merchandise, gray markets are not regarded as strictly illegal (Chen, 2002), though the pharmaceuticals involved may or may not be authentic (Chi, 2009; Foxman & Muehling, 2009). Nevertheless, gray markets typically involve authentic goods in terms of their manufacturing source; it is the distribution of these goods that may violate 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 can be found in the European Union, where pharmaceutical marketers are restricted by regulated prices, creating a niche for gray marketers (Chen, 2002). In this regard, Chen notes 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 bearing genuine trademarks should be regarded as trademark infringement (Chen, 2002).

Drug Diversion, Drug Tourism, and Gray Market Sources

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 through closed-door pharmacies is much larger than many observers might believe. As Ukens emphasizes, "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). 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 glance, this diversion of pharmaceuticals might 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 pharmaceuticals in this fashion adversely affects costs and availability in particular. Ukens reports that, "The most graphic recent example of the gray market at work was the 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).

Although pharmacies are under contract to sell to various healthcare organizations, some pharmacies take advantage of drug shortages to exploit the system. According to Tomsic, "Some small pharmacies break their contracts and sell to secondary, or gray market [distributors]. 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, and 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 of a pharmaceutical increases as it is handled by each secondary distributor, sometimes inflating the price as much as ten times the original amount (Tomsic, 2013). Pharmaceuticals may pass through several intermediaries before reaching their final destination. As Tomsic reports, "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!" (2013, para. 4).

The gray market also includes so-called "drug tourists" — U.S. citizens who travel abroad, generally to Mexico but also to South America and the Netherlands, to purchase legal pharmaceuticals for recreational purposes (Valdez & Sifaneck, 2008). 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 different laws and lower pharmaceutical costs. 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 three-month supply of an unlimited number of prescriptions back with them to the United States (Valdez & Sifaneck, 2008). 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). 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).

Conclusion

The research showed that the gray market for pharmaceuticals in the United States has been estimated to be at least $2 billion, and between $20 and $48 billion worldwide. The research also showed that Public Law 100-293, the Prescription Drug Marketing Act, was passed in 1988 in an effort to address the gray market in pharmaceuticals. Although the Act has experienced some success in combating the pharmaceutical gray market, the law was written before the advent of the Internet, and new ways to circumvent it continue to emerge. The research made it abundantly clear that the main force driving the gray market in pharmaceuticals is greed, and a growing number of pharmacies are exploiting the system to overcharge healthcare organizations with grossly inflated prices. Because shortages of essential medicines or extravagant prices for them can threaten the public health, gray markets in pharmaceuticals represent a clear and present threat to the nation's security interests.