An international strategy for pricing and profits
by Dr. Eckhard Kucher*
Developing an international pricing strategy for a new pharmaceutical product is a highly complex, two-step procedure. It starts with determining the optimal price in single countries and, based on that, tries to harmonise prices across countries in such a way that parallel trade is minimised, potential problems with pricing. authorities are avoided, and total profitability across countries is maximised.
The first step, optimising the price in single countries, was discussed in detail in an earlier article in Scrip Magazines (see Reference). It is not an easy task. It involves a complete analysis of the product's perceived benefit in relation to the benefits of competitor products, plus an estimation of the price elasticity of each single market under consideration. Since price is nothing more than the reflection of the perceived value of the product offered, pricing in single countries involves two basic questions:
- What value is delivered to the market in terms of both product and company performance?
- What value is extracted from the market, ie how high is the price elasticity and what is the optimal price?
The perceived value and the optimal price should be in balance so that where a higher price is charged it does not exceed the additional value delivered to the market. The complexity in translating perceived value into price arises from the fact that value is perceived differently by different customer groups. In addition, different customer groups show different price elasticities - a physician, for example, may be less price sensitive than a pharmacist or a pricing committee.
The second step, the development of an international pricing strategy based on the information derived from single countries, was not considered necessary in the past because barriers between countries still existed. The result was that each country set the price it preferred. This decentralised approach, together with the impact of the different national pricing systems, which range from free-market to completely state-con-trolled pricing, inevitably led to large price differentials between countries, as shown in Figure 1. Germany and France, for example, although neighbours, have on average a price difference of more than 100%. And of course this percentage is substantially larger for some individual products.
It is clear that these large price differentials cannot be maintained. The question is: how, and to what extent, can they be reduced?
Nightmare scenario
Two important trends can be observed. The first is that high-price countries are being forced to reduce prices. Germany has lost much of its high-price image over the past couple of years while the Netherlands recently introduced reference pricing that resulted in a 20% drop in prices. On the other hand there is no evidence that low-price countries are increasing prices.
The result of this trend is a fall in individual country prices over time, leading to an international price comparable with that in the lowest-priced countries. For the pharmaceutical industry this is a nightmare scenario.
The second trend is a move by companies to a more centralised pricing approach which involves an increasingly harmonised pricing strategy for the introduction of new products. In some cases, for example Glaxo with its antimigraine product Imigran and, more recently, Merck with the AIDS drug Crixivan, companies have even tried to implement a uniform price across countries.
However, I do not believe that a uniform price is a good solution. It does, of course, avoid parallel trade and it prevents pricing authorities from using reference pricing to reduce prices, but it also costs companies a great deal of money. With a uniform price, companies do not utilise the enormous profit potential inherent in price differentiation strategies. Some customers are willing to pay more than others. Therefore if all customers are charged the same price, some might not buy because the price is too high while others would be willing to pay more than the company asks. In one case profit is passed up; in the other, money is left on the table.
As price differentiation always yields higher overall profitability than a uniform price, the latter approach is therefore too extreme a measure and is clearly less than optimal. There is no reason why the price of a drug cannot vary between customer groups and between countries. Price differentiation exists in all other industries and it works. ' Why shouldn't it work in pharmaceuticals too?
Price corridors
What is needed is a compromise between the two extremes of trying to maintain price differentials (which can reach more than 100%) and of charging a uniform price across all countries. The solution is a price corridor which sets a minimum and a maximum price (see Figure 2). The difference between the two will depend on the individual product under investigation but can, in most cases, reach 20%-25% without triggering major problems. For smaller, niche products, however, prices may vary by much higher percentages.
The minimum price is a hard lower limit, because no country should be allowed to set a price below this minimum. This implies that some countries might not be able to launch the new product because they cannot establish the price needed. The maximum price is calculated in such a way that, if it is not exceeded, problems with parallel trade and pricing authorities are minimised. It can, however, be exceeded if any one country wants to do so. A very high price in one country will influence only the profit in that country and only parallel trade into this one country. So this decision should be left to the country manager.
"A long-term solution might be to neglect lower-price markets completely until their pricing authorities accept the set minimum prices"
In contrast, a very low price - below the minimum of the price corridor - will influence profitability in all other countries. This decision must there fore be taken centrally. But centralised decision-making does not necessarily mean headquarters - a centralised decision can also be made by an international pricing board on which the major countries are represented.
Deriving this price corridor is a highly complex task because it is not obvious in which countries the prices should be adjusted. All the information required to optimise a price in a single country is also needed to derive the price corridor and of course additional information is required as well, including:
- Size and potential of the individual national markets.
- Price elasticity in individual countries.
- Political implementability of prices, ie reimbursement, etc.
- Dependence of parallel imports on the price differential.
- Developments in exchange rates.
The solution cannot be derived intuitively. So Simon, Kucher & Partners developed a computer program to handle all the relevant information and calculate the price corridor as well as recommending prices for individual countries. For instance, in a weak currency country where the optimal country price is within the price corridor but is at the lower limit, the program might recommend setting a price that is close to the upper limit in order to take account of expected currency devaluation.
Once a corridor has been derived, based on the requirements of the major countries, the smaller countries will have to follow the strategy. The idea is never to endanger 20% or 30% of revenue in a high-price country that accounts for perhaps 25% of the European total just for the sake of launching the product in a country that represents only 1% of the European total. This is simple economics.
Implementation
Planning is one thing, implementation is something else. For instance, what happens to those countries that cannot launch the product because the price is too high? Following the price corridor approach, it is likely that the same countries will fall out of the price corridor for most new products. One solution to this problem is to develop a differentiated product for the very low price countries, perhaps using different brand names, galenic forms and package sizes. But while this will probably buy some time, it will not really solve the problem. It is also against EC law if the purpose of this product differentiation is to avoid price competition in the Community. Therefore a long-term solution might be to sell different substances in different markets or to neglect lower-price markets completely until their pricing authorities accept the set minimum prices.
Implementing the price corridor in those countries where at least the minimum prices are possible is also not a trivial task. As already mentioned, currency fluctuations have to be considered. Another issue is that, in some countries, prices can be fixed by the company while in others they have to be negotiated with pricing authorities.
Since many pricing authorities nowadays use international price reference systems, either formally as in Italy and the Netherlands or informally as in France, the launch sequence of a new product becomes important. Obviously it is not advisable to launch first in a low - price country where this price will then be used as a reference by pricing authorities elsewhere. The overall price level achieved will be very different if the product is first launched in high-price countries, especially in those which serve as reference countries. Thus product launches should be divided into waves. Taking the time from application to launch, which is different from country to country, into consideration, an optimal launch strategy could take the form shown in Figure 3.
The first wave, in those countries in which higher prices are achievable and which are used as reference countries, could be followed by a second wave in Austria, Italy, France and Spain, and then by a third wave in the very low - price countries.
Knowing the complex and interdependent net of international price referencing by national pricing authorities, it is obviously possible to optimise the launch sequence of a new product so that higher prices are achieved. It should be clear, however, that this has its limitations. Postponing a product launch in a major country by one year can cost millions in lost revenue and profitability. Not only are the first year's sales lost, but in every subsequent year sales will also be below the levels that could have been achieved had the launch been a year earlier. Postponing a product launch means that profit is sacrificed every year because the product life cycle is always one year behind. And there is also the possibility that a competitor product may be launched during the delay and this will have an additional negative impact on sales and profits.
"If product launches in major countries have to be postponed, the trade-off between higher prices and lost profits becomes critical"
Optimising the launch sequence has its merits, but if product launches in major countries have to be postponed for a significant length of time, the trade-off between higher prices and lost profits becomes critical. The implications for international pricing in today's environment can be summarised as follows:
- Optimising individual prices in single countries can no longer be recommended because the breakdown of barriers between countries means they cannot be regarded as separate entities.
- The other extreme of a uniform pricing strategy across countries is also not recommended because certain profit potentials can only be realised by price differentiation.
- Price differentials exist in all other industries and they should be as high as possible. Even a certain amount of parallel importing can be tolerated.
- It is crucial that pharmaceutical companies determine the price corridor for their products. This is a highly complex task.
- Stronger centralisation of pricing analyses and authority is needed.
- In implementing the price corridor, the options offered by product differentiation must also be considered.
- Optimise the launch sequence, but be aware of the costs associated with a delay in a product launch.
- If the minimum price cannot be obtained in one country, do not launch the product there.
- Stop selling an established product in a low-price country if the price cannot be increased and sales in larger high-price countries are endangered.
- Establish price corridors for products now. Otherwise market forces will do it and the result will be the nightmare scenario.
Clear advantages
The advantages of a proper pricing strategy are clearly illustrated by the following case study. Two global pharmaceutical companies were each marketing a very similar product for the same indication. In terms of overall product performance there was scarcely any difference. However, the pricing strategies of the two companies were completely different.
Company A did not pursue an international pricing strategy. Basically, headquarters believed that because its affiliates were closer to their own markets than any central function could be, they were better qualified to determine the best price. Each affiliate was therefore allowed to set its own price. Company B, on the other hand, very strictly implemented an international pricing strategy. It determined an international pricing corridor for the product, optimised the launch sequence and differentiated the products.
The results are shown in Figure 4. Prices for Company A's product were below US$1.00 per day in all but four countries. In addition large price differentials resulted in enormous problems with parallel trade. In contrast, Company B realised a price above US$1.50 per day in almost all countries. Lower prices were allowed only in Turkey, Greece and Ireland, because parallel imports were not expected from these countries. In addition, in the two large markets of Germany and France, where prices of more than US$2.00 were achieved, a differentiated product compared with the other countries is being sold. It may or may not be surprising that Company B realised substantially higher market shares and profits.
Reference
1. E. Kucher and K. Hilleke, 'A practical approach to the pricing of new products', Scrip Magazine, November 1996.
* Dr. Eckhard Kucher is cofounder and President of the consultancy company, Simon, Kucher & Partners, which has offices in Bonn, Germany, and Cambridge, Massachusetts, US.
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