[e-drug] vertical integration and drug pricing

["Chandresh Harjivan" <chandresh.harjivan@said-business-school.oxford.ac.uk>]

E-DRUG: vertical integration and drug pricing
---------------------------------------------

Dear E druggers,

I was hoping to get some comments to help a friend in South Africa, he
describes his situation below:

"I act for eight full line wholesalers in SA that are fighting for their
survival in circumstances where a number of manufacturers have formed a
cartel to set up their own exclusive distribution network. It is called IHD
[International Health Distributors] and I am sure that you will be familiar 
with it. 

There is a belief that the
elmination of wholesalers will eliminate the middelman and result in a
saving which ought to translate into cheaper medicines.

All of the research that I have done thus far however reveals that this
premise is not correct for the following reasons:

1. Someboby must perform the function of receiving medicines imported in
bulk palletized loads, break the bulk and warehouse it. From there it must
be sorted and picked and packed for fine distribution to the thousands of
retailers and dispensing doctors;

2. It is obviously in the consumers interest to ensure that these functions
are executed in the most cost effective manner regardless of whether or not
the job is done by independant wholesalers or multinational manufacturers.
Indeed if the latter are better able to perform this function and this leads
to the demise of the wholesalers then so be it. Anti trust law is not
designed to protect competitors but to ensure that the consumer gets the
best deal.

3. Untill IHD entered the scene all of the so called full line wholesalers
carried a full range of products and competition between them ensured that
their margins remained reasonable(between 1% and 1.5% nett profit after
tax).

4. The members of the IHD cartel have however precluded their members from
dealing directly with the wholesalers on the same basis as before making it
impossible for them to compete with IHD and the cartel have in effect given
their own company  the exclusive right to distribute approximately 30% of
all pharmaceutical products produced in SA.

5.Cost comparisons between IHD and the wholesalers suggest that distribution
via IHD is more expensive than if use is made of wholesalers because the
latter have a better economy of scale and are subjected to the competitive
forces to which I have already made reference whilst IHD are protected from
competition.

6. The million dollar question is then why the manufacturers have gone to
the trouble and expense of creating their own exclusive distribution
network.

A number of reasons have been advanced by them that are in my view an eye
blind for the real reason which as always is simply because it enables them
to increase their profits. This they do by gaining control over the
distribution of their products and compelling retailers and dispensing
doctors to purchase from them at the prices which they dictate. In practise
this has resulted in the manufacturers retaining for themselves a
substantial portion of the discounts on blue book prices which the
wholesalers used to pass on to retailers. Retailers were up in arms about
this but remained at the mercy of the manufacturers because of the exclusive
distribution arrangement with IHD.At the end of the day retailers pay more
and consumers suffer... or so the argument goes.

As a pharmacist I am sure that you have expert knowledge of these matters.
You will probably also be aware of the fact that last year the Competition
Board ruled in favour of the wholesalers finding that  the IHD cartel was
anti competitive and that the Minister of Trade  and Industry should undo
it. The Minister resolved in his wisdom that it would be preferable to do
nothing in terms of the old act but rather to wait until the new act came
into effect late last year. This he did because the IHD cartel threatened 
to take him to court and he was of the view that it would be quicker to 
proceed in terms of the new act which he believed was better capable of 
withstanding legal scrutiny by the courts.

We are busy with the application in terms of the new act.

I hope that the above gives you some background in what is a very complex
matter. As you can imagine there are a multitude of issues. Central to most
is the issue relating to the cause of the high price of medicines in SA.

Regards,

Alan"

Any ideas would be helpful,

Sincerely

Chandresh Harjivan
Corpus Christi College
Oxford University
OX1 4JF
telephone: (44) 07980 196 767

Email: chandresh.harjivan@said-business-school.oxford.ac.uk  
[please add email to your signature - thanks WB]
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