Big Pharma advantage: discovery or risk mitigation?

The market performance of many big pharmaceutical companies has been middling, as the sector’s competitive position is perceived to be under several threats. The drug pipeline appears to be drying up and geared more toward lifestyle enhancement than life savings. Costly and reputation-damaging liability suits are proliferating. Pricing pressures are relentless. They come from pressure groups such as AIDS patients; but they are reinforced by public authorities, not only in the developing world but also in the US and in Europe, as governments seek to slow down the relentless progress of health expenditures.

Big Pharma's public image may not be as bad as that of tobacco companies - but it is getting closer. Thus, in his recent book, “The Constant Gardener”, John Le Carre makes corporate pharma managers into murderous villains, comparable to, if not worse,than the KGB and Stasi baddies of his earlier writings.

In this context, the verdict of the European Court of Justice, published on September 27, in a case opposing Glaxo SmithKline (GSK) and the European Commission, can be seen as a welcome relief not only by GSK but by the larger Big Pharma group.

The case was brought by GSK in response to a decision by the Commission to allow parallel trading in GSK-manufactured drugs.  Under a parallel trading scheme, it is possible to import drugs, without manufacturer's permission, from countries where they are sold more cheaply. Thus a UK wholesaler can import a drug from Greece and sell at a much lower price than that fixed by the manufacturer for the UK. To the extent that drugs are reimbursed by governments, parallel trading can generate substantial savings.

Not surprisingly, the EU encourages parallel trading and conversely considers restrictions on it as contrary to EU competition law. In 2001, it refused to approve a discriminatory pricing scheme for GSK’s Spanish wholesalers, which discouraged parallel trading (drugs destined for the Spanish market were sold by GSK at considerably lower prices than drugs exported outside Spain). GSK appealed the Commission’s decision to the European Court of Justice. Its argument was that the parallel trading restrictions were a crucial part of its strategy, which seeks to balance strong pricing pressures and the need for high R&D expenditures in order to promote innovative new drugs. 

It looks like the ECJ has broadly accepted the validity of GSK’s argument. Its ruling annulled partially the EC decision. Although the Court affirmed the general principle of parallel trading, it found serious fault with Commisssion’s economic reasoning, which was deemed unbalanced. According to the Court, the Commission failed to recognize the potential social benefit created by parallel trading through its contribution to the financing of pharmaceutical innovation.  The Court directed the Commission to take a second look at its decision, taking into account all the factual arguments and the relevant economic evidence. In effect, both parties are back to the original situation in 2001, when GSK asked the Commission either to declare its pricing scheme in conformity with the EU competition law or to grant it an exemption on the ground of promotion of technical progress.

The decision is finely calibrated: it refutes the Commission’s argument that the main objective of discriminatory pricing was to restrict competition. On the other hand, it accepts the subsidiary conclusion of the Commission that discriminatory pricing may result in restriction of competition. Similarly, the Court finds that parallel trading has definite social and economic benefits but also recognises the merit of GSK’s argument that discriminatory pricing contributes to the financing of innovation.

The Court decision is only a partial victory for GSK. The Commission may still seek to limit discriminatory pricing and to promote parallel trading. Nevertheless, the decision represents an important legal milestone for Big Pharma, to the extent that it recognises its economic specificity and accepts the argument about the critical role of Big Pharma in financing innovation. In its press release, Glaxo wrote that it “is pleased that the [ECJ] has recognised that the pharmaceutical sector has specific characteristics, unlike other sectors, which the Commission should have taken into account.”

This argument may sound paradoxical as Big Pharma increasingly relies on outside sources such as biotechnological firms, specialised research outfits and universities for new molecules, drugs and treatment ideas.  However, while such ideas and discoveries constitute a necessary condition of pharmaceutical innovation, they are no longer sufficient, as the process of regulatory approval and marketing of new drugs becomes more protracted and expensive.

It is in this area that Big Pharma remains irreplaceable: its specificity is no longer in generating discoveries but in economic and regulatory risk mitigation and management.