Can Higher Prices Increase Market Share?

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[P]rocurement rules for the Medicaid program create incentives that sometimes drive pharmacies to forego purchasing the lowest-cost ... generic drug(s).

The growing generic drug market is generally believed to provide lower-cost alternatives to brand-name drugs and to contribute to lower healthcare costs. However, in Perverse Reverse Price Competition: Average Wholesale Prices and Medicaid Pharmaceutical Spending (NBER Working Paper No. 19367), authors Abby Alpert, Mark Duggan, and Judith Hellerstein find that the procurement rules for the Medicaid program create incentives that sometimes drive pharmacies to forego purchasing the lowest-cost version of a given generic drug and to choose instead a version that costs the Medicaid program more and that will also deliver a higher profit. In turn, generic drug manufacturers have an incentive to compete for pharmacy market share by driving up the prices paid to pharmacies by Medicaid. The authors report that a federal government crackdown on Medicaid pricing practices in 2000 led to a 45 percent decrease in the Medicaid market share of the drugs targeted by the crackdown, which were generic drugs with high Medicaid reimbursement levels.

The fraction of drug spending paid for by governments and by private insurance companies has grown from 34 percent in 1980 to 92 percent in 2010. Consumers now account for only 8 percent of such payments. The sale of generic drugs also has risen steadily over the years, accounting for 75 percent of total prescriptions dispensed in the United States in 2009 compared to 50 percent in 1999.

The authors study the period 1994 to 2004, when Medicaid accounted for nearly 20 percent of all prescription drug expenditures in the United States. Medicaid's dominant method of reimbursing pharmacies for prescriptions dispensed to Medicaid recipients then, as now, was based on a benchmark price called the average wholesale price (AWP). The AWP approach allows pharmacies to profit from Medicaid reimbursement when there is a "spread" or a difference between reimbursements and a pharmacy's actual acquisition costs. While the designers of the AWP approach anticipated that pharmacies would seek to maximize this spread by searching for the versions of generic drugs with the lowest acquisition costs, in practice pharmacies sometimes opt instead to buy generic drugs with the highest AWP.

The benchmark AWP, upon which reimbursement to pharmacies is based, has been traditionally reported by generic drug producers themselves and until recently had been subject to essentially no independent verification. In the 1990s, the U.S. Department of Justice (DOJ) launched a series of investigations into Medicaid drug procurement practices, culminating in a 2000 pronouncement that many reimbursement prices had been artificially inflated and that the AWP used to reimburse pharmacies should be reduced by as much as 95 percent for about 400 generic and other off-patent drug products.

Alpert, Duggan, and Hellerstein examine the changes in pharmacy behavior associated with the DOJ's intervention in the Medicaid generic drug market. They hypothesize that manufacturers of generic drugs were competing for pharmacy market share by bidding up reported prices that entered the AWP-based reimbursement calculation, thereby increasing the spreads earned by pharmacies. The authors find that the DOJ-targeted drugs cost the Medicaid program on average about three times more than bioequivalent drugs in 1999. These drugs had an average Medicaid market share that was more than five times as large as those from competitors before the DOJ intervention, and their Medicaid market share fell by about 45 percent between the intervention and 2004. The higher the spread and the market share for a particular drug before the DOJ intervention, the more its price and Medicaid market share were likely to decline afterward.

--Jay Fitzgerald