Anti-competitive excessive pricing in the pharmaceutical sector: the UK and Italian Pfizer/Flynn and Aspen cases

Combating excessive pricing in the pharmaceutical sector has recently become a top priority in the enforcement agenda of national competition authorities. Over the past year anti-competitive excessive pricing practices have been detected by the UK Competition and Market Authority (CMA) and the Italian Autorità Garante della Concorrenza e del Mercato (ICA) in the Pfizer/Flynn and Aspen cases, respectively. The post compares the methodologies followed by the CMA and ICA to establish that the pricing policies implemented by the investigated firms were excessive and breached competition. Correctly understanding how the excessive price test is administered by competition authorities is then important for drug manufacturers to assess whether the pricing policies are prohibited by competition law with the risk of being levied hefty fines. This issue is also of relevance for national health authorities and patients. Feeling aggrieved by apparently exploitative pricing policies applied by manufacturers to the drugs they purchase, health authorities and patients may consider reporting to competition authorities reporting allegedly excessive prices.

The facts of the case in Aspen and the decision of the ICA

Aspen was a South African manufacturer of generic drugs that marketed in Italy several anti-cancer drugs, the so-called ‘Cosmos drugs’, which contained different active ingredients whose patent protection has since long expired. The essential therapeutic function of the Cosmos drugs was to treat cancer pathologies, especially those affecting younger and older patients. The drugs were included in a wider package of pharmaceutical products whose marketing rights, namely trade mark rights and market authorizations (MA), had been purchased by Aspen from the originator GlaxoSmithKline in 2009.

The prices for the Cosmos drugs were regulated by the Italian national health system (INHS) and patients were entitled to the full reimbursement of the purchasing price from the INHS. The ICA ruled that, by taking rather an aggressive stance when negotiating new selling prices for the Cosmos drugs with the Italian Drug Agency (AIFA), Aspen succeeded in obtain a considerable price increase, with new prices being 300%- 1,500% higher than the old ones. The ICA believed that the new prices were excessive and that, by imposing such prices, Aspen abused its dominant position. This conduct infringed Article 102 TFEU and, accordingly, the ICA imposed on Aspen a € 5 million fine. All the ICA’s findings were recently upheld on appeal by an Italian administrative court

The facts of the case in Pfizer/Flynn and the decision of the CMA

Until September 20121 the selling prices for Epanutin, a drug used for the treatment of epilepsy and prepared with the active ingredient of phenytoin sodium, were regulated by the UK national health system (UKNHS) under the Pharmaceutical Price Regulation Scheme (PPRS). Also, phenytoin sodium was off-patent since long. Then, the drug originator, Pfizer, entered into an agreement with its distributor Flynn Pharma (Flynn). Under this agreement, Pfizer assigned its MA for phenytoin sodium to Flynn. Pfizer also committed to produce and supply, on an exclusive base, the phenytoin sodium capsules to Flynn. At this point, Flynn debranded or genericized the Epanutin drug that was marketed from then on with the generic name of phenytoin sodium. As a result, the drug was no longer subject to the price regulation mechanism of the PPRS. And, starting from September 2012, the CMA observed substantial increases in the prices for the phenytoin sodium capsules charged by Pfizer to Flynn and in those charged by Flynn to dealers. The new prices imposed by Pfizer and Flynn were between 780%-1,600% and between 2,300% and 2,600% higher than the previous ones, respectively. The CMA reached the conclusion that these prices were excessive and that, consequently, Pfizer and Flynn had abused their dominant positions in the markets for the manufacturing and distribution of Pfizer-manufactured phenytoin sodium capsules. Then, Pfizer was levied a £ 84.2 million fine and Flynn a £ 5.2 million fine. An appeal lodged by Pfizer and Flynn against the CMA decision before the Competition Appeal Tribunal is currently pending. Hearings are expected to be held in November.

The methodologies applied by the CMA and the ICA to establish an excessive pricing

Both the CMA and the ICA employed the two-limb test developed by the CJEU in United Brands. The first step of the test requires a price-cost analysis with a comparison of the costs incurred by the dominant firm with the prices it charged. The second limb of the test involves a fairness assessment to establish whether the charged prices are unfair in themselves or in comparison to competing products.

a)     The price-cost analysis

The ICA compared the prices and costs of Aspen with two different methodologies: the contribution margin analysis and the cost-plus analysis. Under the contribution margin analysis, the ICA calculated the gross contribution margin made by the sale of each of the Cosmos drug to the net operating profit of Aspen. This analysis revealed that before the price increase the revenues generate by the sale of the Cosmos drugs covered the total costs. The price increases obtained by Aspen, then, led to a substantial increase of the contribution margin of the drugs which was reflected by considerably higher profit margins for Aspen. Similar results were given by the cost- plus analysis. The ICA identified a reasonable measure of the profits of Aspen in a 13% rate of ROS. ROS was considered to be an appropriate measure of the profits of Aspen because the latter invested limited capital in the R&D activities concerning the Cosmos drugs. The reasonable return for Aspen was determined at a 13% ROS as that corresponded to the average ROS of the larger generics over the 2013-2014 period. The sales revenue achieved by charging the contested prices were well above all the production costs reasonably incurred plus the applied ROS rate. More precisely, revenues were 100%-400% higher than costs. Such figures were much higher than the differences between revenues and costs observed in excessive price cases dealt with by other competition authorities (European Commission, Case COMP(C-1.36915 Deutsche Post AG-Interception of cross-border mail; Competition Appeal Tribunal of the UK, Case No 1046/2/4/04 [2008] Albion Water v Water Services Regulation Authority).

The CMA, instead, only relied on the cost-plus methodology. It identified the relevant costs to be considered in the direct and a relevant portion of indirect costs. For the CMA, as a general rule, ROCE (Return on Capital Employed) would be the most appropriate measure of a reasonable return for Pfizer, being a well-known measure of a company’s profitability. The formula for calculating the ROCE is: Earnings before Interest and Taxes (EBITA)/Capital Employed. However, ROCE was not appropriate in this case. Because of the absence of a dedicated production line for each of the Pfizer’s drugs, it would be difficult to determine the capital employed for the manufacturing of phenytoin sodium capsules to be computed in the ROCE calculation.

Then, the CMA opted for ROS (Return on Sales) or operational profit margin, which is calculated with his formula: Net income (before interest and tax)/Sales. The CMA believed that a 6% ROS should be a reasonable rate of return for Pfizer. This roughly corresponds to the Pfizer’s internal ROS and to the ROS that pharmaceutical companies are allowed to earn on the sale of branded drugs under the PPRS. Moreover, the CMA observed that the phenytoin sodium capsules are a very old drug with no recent development or innovation and that the risks for Pfizer in supplying these drugs are quite low. Hence, a reasonable ROS considered in the cost-plus analysis should not be higher than the returns achieved by Pfizer across its UK business. This analysis revealed that the effective earnings of Pfizer were between 29%-690% higher than the estimated reasonable rate of return and these were pure excess profits. A ROS not higher than 6% was also considered a reasonable rate of return for Flynn, given its limited risk and the age of the drugs. The analysis showed that the Flynn’s prices exceeded its reasonable return between by 31% and 133%.  

b)     The fairness assessment

The ICA established that the new Aspen prices were unfair in themselves for manifold reasons. First, whether the starting prices of the Cosmos drugs were at such level to cover the R&D investments and the marginal costs, the new prices considerably increased the margin profit of Aspen. Second, the new prices asked for by the dominant firm were devoid of any rational justification. Indeed, at the time of the acquisition of the Cosmos drugs from GSK, the drugs already generated a positive gross margin. The Aspen’s submission that new prices were needed to align its pricing policies in Italy with the prices charged in the other EU Member States to prevent parallel imports and to comply with pharmacovigilance obligations were considered as groundless by the ICA. Third, the returns achieved by Aspen on the investments made for the acquisition of the trademark rights on the Cosmos drugs were substantial and much larger than the cost of capital in the pharma industry. Fourth, the new prices did not bring about any benefit for patients and the national health system because the quality of products was not improved. Fifth, the ICA was rather critical of the business model followed by Aspen. It stressed that the Cosmos drugs were mainly used to treat oncology pathologies of children and the elderly that did not have alternative options. Though Cosmos drugs were not off-patents since long, they still had a very strong market position due to the absence of similar products. Neither Aspen had to amortize the R&D investment, already sustained by the originator, nor it had to bear the production costs of the drugs, whose manufacturing process was outsourced to third parties. Therefore, Aspen could charge prices unrelated to the associated costs and the value of the products sold to customers. Sixth and finally, the new prices had negative economic effects on the INHS that had to pay more for the Cosmos drugs, reducing the availability of public funds for the other policies.

Similarly, also the CMA established that the prices charged by Pfizer and Flynn were unfair in themselves. The CMA ruled out that any relevant non-cost related factors had to be considered to determine the economic value of the drugs supplied by Pfizer and Flynn. Thus, the economic value of the drugs corresponded to the cost pluses of Pfizer and Flynn, respectively. In the CMA’s view the substantial gap between the prices charged and the economic value indicated that such prices are unfair in themselves. This finding was corroborated by the characteristics of the drugs. First, the CMA stressed that the phenytoin sodium capsules were a very old drug that Pfizer sold for many years at much lower prices. Second, the price increases did not follow any material change of the manufacturing and supply costs of the drugs or any innovation. Third, neither the price increase reflected any changes to the drugs nor additional benefits were created for patients. With regard to Flynn, the CMA observed that it took on little commercial risks and played a limited role on the supply chain, selling the drugs to captive patients at the prices it liked.  

Conclusion

The overpriced drugs in Aspen and Pfizer/Flynn were old since long off-patent products. mainly supplied to captive patients and were the target of a debranding marketing strategy. Arguably, both the ICA and CMA applied the United Brands test in a conservative way, taking into consideration the data, whether about costs or revenues, which were the more favourable for the dominant firms. As for the fairness limb of the test, the ICA and CMA considered similar or identical facts or circumstance, stressing many times that the drugs were rather old, as reflected by the fact that their patent protection expired since long. They also pointed out that none of the firms involved in the marketing of the drugs had to bear the costs of R&D activities and that the substantial prices increases were not reflected in improvements for health authorities and captive patients. The ICA and CMA also reproached the dominant firms for unethical behaviour because their pricing policies harmed patients that had no other choice than to purchase the Cosmos drugs or the phenytoin sodium capsules produced by Pfizer.

Where the analysis of the ICA and CMA diverged was in the price/cost comparison limb of the test. While both the two acting competition authorities applied the cost-plus methodology, in addition to that the ICA also relied on the contribution margin analysis. Turning to the cost-plus analysis, the ICA and CMA took ROS as a measure of reasonable profit that the parties were allowed to earn. Yet, the ROS rate chosen by the ICA was higher than that taken by the CMA, which may have been influenced by the UK regulatory regime. Indeed, under the PPRS provided for a 6% target for return on overall sales of drugs.