Economics for Pharmaceutical Management Notes

Economics as a Tool for Making Choices

  • Health economics involves understanding resource-allocation decisions (medical and nonmedical) affecting health under scarcity and uncertainty.
  • Pharmaco-economics focuses on medicines' economic evaluation.
  • Health managers make choices among programs, goals, objectives, strategies, and activities.
  • Evidence-based medicine combined with pharmaco-economic analysis helps in medicine selection, especially with increasing pressure to demonstrate value for purchases or subsidies.
  • These methods have been effective in high-income countries' health insurance/pharmaceutical subsidy schemes but are also relevant to low- and middle-income countries.
  • Pharmaceutical management is complex, involving:
    • Research and discovery
    • Product development
    • Safety and efficacy testing
    • Manufacture
    • Distribution
    • Prescription
    • Dispensing
    • Consumption
  • The first four elements constitute costs incurred before manufacturer distribution.
  • Manufacturer prices are often multiples of the marginal cost of production to recover costs and generate profit.
  • The patent system allows manufacturers to act as monopolists and charge what the market will bear.
  • Retail prices depend on the patent system and the last four processes listed above.
  • Health economics methods applied to medicine selection must consider stakeholder roles and process complexity.
  • Economic analysis can augment experience and common sense but not fully replace them.
  • Real-world decision-making must consider political, professional, and commercial realities.
  • Achieving optimal value for money is a goal, and pharmaco-economic methods can help deliver greater value in the long term.
  • Health economics is a rigorous discipline, and problems arise from limitations or biases in clinical data.
  • Organizations need clinicians, epidemiologists, statisticians, and economists to conduct analyses well.
  • Regional cooperation may be necessary for widespread proficiency.
  • Complex health economic analyses of individual medicine products are not always necessary in most low- and middle-income countries. Instead, they are selectively applied to public health programs or expensive products from a single source.
  • Formal pharmaco-economic evaluations should align with pharmaceutical management policy (essential medicines lists, generic medicines policies, procurement, distribution systems, tariffs, taxes, and rational medicine use).

Basic Economic Concepts

  • Economics evaluates choices based on costs and benefits.
  • Table 10-1 lists examples of resource-allocation decisions.
  • Key concepts:
    • Scarcity: Resources are limited, requiring choices about resource use.
    • Opportunity Cost: Benefits given up when choosing one option over the next best alternative.
    • Marginal Costs and Benefits: Additional costs incurred and benefits gained by increasing output.
    • Incentives: Influence behavior through monetary and non-monetary rewards or penalties.

Scarcity

  • Resources are never sufficient; choices must be made about resource use.
  • Resources include money and time.

Opportunity Cost

  • Choices involve trade-offs and potential benefits given up.
  • Example: The opportunity cost of running an inventory management training course is the forgone rational medicine use course.

Marginal Benefits and Costs

  • Decisions often involve spending a bit more or less on activities.
  • Marginal costs are the additional costs of doing a bit more.
  • Marginal benefits are the additional benefits that result.
  • Incremental cost-effectiveness ratio: relationship between additional costs and benefits.
  • Example: A program manager deciding whether to keep a clinic open an extra hour considers the marginal cost (extra salaries, utilities) versus the marginal benefit (additional children vaccinated).
  • Incremental cost-effectiveness ratio would be expressed as the cost per extra child vaccinated.

Incentives

  • Compensation (reward or penalty) influences behavior.
  • Governments may provide financial incentives for parents to immunize children.
  • Governments have an incentive to provide preventive health care as it reduces the cost of curative care.
  • Moral hazard: the tendency to overuse facilities if they are free of charge.
  • User fees reduce care-seeking behavior among poor patients, potentially leading to negative health outcomes.
  • Governments can levy fines for substandard products to encourage pharmaceutical producers to maintain quality.
  • Controls and incentives can influence consumers and providers to choose lower-priced medicines.

Economics of the Public Sector

  • The appropriate role of government in the health sector has been debated.
  • The social welfare perspective supports broad government involvement.
  • The market economy perspective suggests government intervention only when the market fails.
  • Governments should provide public goods and services with positive externalities (immunization) and merit goods (health education).
  • Policy makers must address distribution issues: who pays and who benefits.
  • Subsidies can encourage consumption of health services beyond what individuals would pay.

Goals of Public Expenditure

  • Traditionally, the public sector's role included law and order, national security, infrastructure, and providing certain goods/services.
  • These activities are termed public goods, externalities, and merit goods.
  • Many governments have experimented with privatizing areas previously regarded as the sole province of the public sector.

Public Goods

  • Essential services consumed collectively (national defense, policing), utilities (street lighting, sewage), and public health services (aerial spraying) are public goods.
  • Public goods are nonexcludable and nonrival.
  • Private sector provision may be impractical.

Externalities

  • External effects extend beyond the directly involved party.
  • Immunization and communicable disease control have positive externalities.
  • Governments usually fund public goods with positive externalities or subsidize their use.

Merit Goods

  • Merit goods are good in themselves (health services for the poor).

  • Populations want these services to be provided, but private markets may not provide them.

  • Government creates supportive environments for the private sector by encouraging stability, ensuring infrastructure, and enforcing contracts.

  • Arguments for an active public sector are made in developing countries with low private investment.

  • Governments there can sometimes have issues with corruption and lack of transparency.

  • Government roles in the pharmaceutical sector range from total control to minimal intervention.

Understanding the Private Sector

  • Private-sector resource allocation decisions are determined by market interactions and price.
  • The private sector may be seen as focused on profit at the expense of equity and quality.
  • Private sector plays an important role in the health sector (production, distribution and sale of pharmaceuticals as well as direct provision of health services through private clinical practices, private hospitals, and retail drug sellers).

Markets and Competition

  • Private sector is characterized by buyers and sellers negotiating the exchange of goods and services through price.
  • In the pharmaceutical sector, sellers include manufacturers, wholesalers, pharmacies, and retail outlets; purchasers may be government, private, or non-governmental facilities, or consumers.
  • Competitive markets allocate resources efficiently, ensuring resources reach those willing and able to pay.
  • Suppliers enter the market when they can make a profit.
  • Incentives encourage investment and response to consumer demand.
  • Under competitive conditions, suppliers earn reasonable profits; increased profits attract competitors offering lower prices.
  • Competition occurs based on price, quality, reliability, service, or capacity.
  • Scientific advances underlying innovative pharmaceuticals are another example of a public good.
  • Various mechanisms have been developed to encourage research and development in medicines and vaccines for neglected diseases.
  • Advance market commitment guarantees a viable market for a new medicine or vaccine.
  • Intellectual property system gives innovators a time-limited monopoly in exchange for revealing their invention, hoping for a greater rate of innovation in the long run.
  • Patents are granted for twenty years, but the effective patent period is less due to development time.
  • After patent expiration, generic suppliers compete, and prices decrease closer to marginal production costs.
  • Public and private insurance distorts the pharmaceutical marketplace.
  • Governments negotiate prices to counteract single-seller power.
  • The competitive model is replaced by multiple monopolistic suppliers and large purchasers.

Economies of Scale

  • In competitive markets, suppliers efficiently produce goods and services using the least-cost combination of inputs.
  • Economies of scale occur when larger production leads to lower average costs.
  • Beyond some output level, average costs may increase.

Economies of Scope

  • Economies of scope result when combining activities lowers average costs.
  • Private distribution networks may benefit from combining pharmaceutical delivery with other goods and services.

Ethics and Business

  • Nongovernmental organizations and public-sector groups attribute unethical motives to the private sector.
  • Long-term interests of private providers incentivize good-quality service.
  • Arguments have centered on the price at which they sell their products, particularly in poorer countries.
  • With the help of intense lobbying from advocacy groups, however, the pharmaceutical industry appears to be recognizing its wider global responsibilities and is addressing its damaged reputation.
  • Pharmaceutical suppliers will be happy to sell medicines at differential prices in poor countries, as long as those prices are above their marginal costs of production and distribution and prohibitions against reexporting to higher-priced markets are enforceable.
  • Research-based companies have been using differential prices to sell their products on different markets.
  • Differential pricing includes contraceptives, vaccines, and antiretroviral medicines.
  • Nonprofit organizations are developing new medicines for conditions such as tuberculosis, malaria, leishmaniasis, and trypanosomiasis.
  • Some are part of large international initiatives, and much funding has come from the private sector.
  • Several initiatives are public/private-sector partnerships, involving pharmaceutical manufacturers (see Chapter 3 on intellectual property and access to medicines).
  • The result has been considerable blurring of the traditional barriers between the public and private sectors in pharmaceutical research, development, and distribution.

Government Interaction with the Private Sector

  • Government interacts with the private sector through government purchases of pharmaceuticals and supplies.
  • Government involvement aims to correct imperfect private markets.

Market Failure

  • Market failures in the medical and pharmaceutical marketplace include:
    • Insurance shields patients and physicians from the social costs of their health care decisions.
    • Information acts as a public good, while the patent system creates monopoly power.
    • Purchasers lack information about price and quality, benefiting sellers.
    • Regulatory requirements create barriers for new manufacturers.
  • Patients rely on clinicians, producers, and governments to ensure quality, safety, and efficacy.
  • Government interventions include medicine inspection, pharmacist licensing, and medicine registration.
  • Safety standards make market entry difficult for new companies.
  • Economic efficiency requires that medicines are effective, affordable, represent value for money, and are used appropriately.
  • Governments also aim to achieve equity in the distribution of funds and services.
  • Lack of access to essential medicines results in avoidable mortality, suffering, resentment, and economic decline.
  • Governments correct inequities, as access to essential medicines is a human right.
  • Private-sector decision-making is driven more by profit than by equity considerations.
  • The relatively high cost of pharmaceuticals compared to that of other goods suggests that without government involvement, the poor would be denied access to lifesaving medicines.

Types of Government Interventions

  • Government interventions are needed to correct market imperfections, ensure safety and efficacy, and improve access and affordability.
  • These aims are advanced by legislation, government purchasing power, and subsidies.
  • Regulation ensures private-sector actions align with broader societal welfare.
  • Objectives include improvements in quality, efficiency, or equity.
  • Instruments used to regulate the private sector include controls on medicine and service quality; controls on imports; and registration and licensure of pharmacists.
  • Restrictions have been imposed on the prices at which pharmaceuticals can be sold.
  • A number of issues should be considered in evaluating the potential effect of regulation:
    • The extent of coverage (does it include both public and private sectors?).
    • The capacity of government to monitor compliance.
    • The extent of enforcement and exemptions.
    • The extent to which the private sector can circumvent or evade regulations.
  • The federal government subsidizes the use of pharmaceuticals through the maintenance of a “positive” formulary, called the Pharmaceutical Benefits Schedule (PBS).
  • The Processes have survived multiple technical and ethical challenges, notably but not exclusively from industry.
  • The PBS is a positive formulary, in that the PBAC does not seek to limit choice or restrict the numbers of medicines within a classification.
  • Using pharmaco-economic analyses in decision making is not a panacea for rising pharmaceutical budgets.
  • Using pharmaco-economic analyses in decision making is not a panacea for rising pharmaceutical budgets.

Challenges to Government Interventions

  • Government intervention may fail.
  • Governments face threats to their effectiveness.
  • Informed decisions about public involvement must acknowledge sources of government ineffectiveness.
  • Inefficiency in service delivery arises from a lack of individual incentives for good performance, bureaucratic inflexibility, and political pressure to create employment.
  • Inequities in revenue collection can reduce health services.
  • Interest-group pressures can influence bureaucrats.
  • Lack of good governance and corruption can be revealed in self-interested manipulation of the medicine selection process, corruption in the award of tenders, nepotism in the appointment of key staff, sales of medicines on the outside by health staff, and other destructive practices.

Efficiency Concepts

  • Efficiency means getting the most output for a given quantity of resources or achieving a given output at minimum cost.
  • Economic efficiency refers to economic systems that can provide more goods and services to society without using more resources.
  • Scale efficiency occurs when the production costs are reduced because of higher production volume.
  • Productive efficiency in a health system refers to maximizing health outcome for a given cost, or the minimizing cost for a given outcome.
  • Allocative efficiency: Undertaking the best combination of activities to achieve the greatest net benefit to the community.
  • Technical efficiency: Determining the right quantities and least-expensive combination of inputs to achieve a given outcome.

Allocative Efficiency

  • Decisions affecting allocative efficiency are often made at the policy level.
  • A decision to reduce spending on pharmaceuticals in order to pay salaries could lead to inefficiency if staff are then underused because of other shortages.

Technical Efficiency

  • Technical efficiency means obtaining the maximum physical output from inputs to reach a goal.
  • Selection of medicines should consider comparative efficacy and cost-effectiveness.
  • Procurement can be made more efficient through the use of competitive international tendering which can result in substantial price reductions.
  • Determining the appropriate quantities of medicines to buy also affects efficiency.
  • In pharmaceutical distribution, when not enough transportation is available or vehicles are often inoperative, personnel may be underused.
  • Rational use of medicines has the potential to improve efficiency.

Program managers can control only some of the factors that affect technical efficiency.

  • Incentives and management structures are important.
  • Health care decision makers can use information on efficiency to improve the current situation and make better plans related to performance, costs, and staff utilization.

Economic Evaluation of Pharmaceutical Products

  • Pharmaco-economics is the analysis of the costs and benefits of medicine therapy to health care systems and society.
  • Pharmaco-economic analyses involve comparisons.
  • Economic evaluation refers to analytical tools that identify the greatest benefit compared with cost.

Four methods of economic analysis are commonly distinguished:

  1. Cost-minimization analysis (CMA)
  2. Cost-effectiveness analysis (CEA)
  3. Cost-utility analysis (CUA)
  4. Cost-benefit analysis (CBA)

Cost-Minimization Analysis (CMA)

  • Calculating the cost of alternatives with the same outcome to identify the lowest-cost option.
  • Benefits must be measured in the same/equivalent units, and alternatives need to produce the same quantity of benefits.
  • The choice is to identify the lowest-cost alternative.
  • The challenge is to define an acceptable degree of therapeutic equivalence before comparing the costs of two regimens.
  • Noninferiority is the term used to define equivalence.

Cost-Effectiveness Analysis (CEA)

  • Measuring both costs and benefits of alternatives.
  • Finding the strategy with the best ratio of benefits, measured in therapeutic (clinical) or program effects, per money unit of expenditure.
  • Outcomes are often described in natural units.
  • The challenge is to identify the option with the lowest cost per unit of benefit gained.
  • Cost-effectiveness must be considered alongside therapeutic effectiveness.
  • The incremental cost-effectiveness ratio, which compares the new (more effective) medicine with existing treatment, should be used to commit additional funds.

Cost-Utility Analysis (CUA)

  • The same as cost-effectiveness analysis, except that benefits are measured in “utility” units, which in theory can be compared across different disease states
  • Program outcomes are measured in utility units.
  • The most common utility measures are the quality-adjusted life-year (QALY) and the disability-adjusted life-year (DALY).
    DALYs combine mortality and morbidity into a single measure.
    *
  • QALYs calculate benefits in terms of life-years saved, weighted by the quality of those years.
  • QALYs are controversial because individual qualities of life are difficult to compare.

Cost-Benefit Analysis (CBA)

  • Comparing the costs and benefits of an intervention by translating the health benefits into a monetary value, so that both costs and benefits are measured in the same unit
  • Both costs and outcomes are measured in financial units.
  • Its main advantage is that it allows the comparison of programs with different outcomes.

Steps for Conducting a Cost-Effectiveness Evaluation

  • Define the objective.
  • Enumerate the different ways to achieve the objective.
  • Identify, measure, and value the benefits of each option.
  • Identify, measure, and value the costs of each option.
  • Calculate and interpret the cost-effectiveness of each option.
  • Perform sensitivity analysis on the conclusions.

Identify, Measure, and Value the Costs of Each Option.

  • Recurrent cost: The cost of goods that are consumed or used up over the course of a year (for example, staff, pharmaceuticals, fuel).
  • Capital cost: The cost of goods that are intended to last for longer than a year (such as buildings, vehicles, medical equipment).
  • Annualized capital cost: Capital cost per year of useful life for a building, vehicle, or other capital item.
  • Fixed cost: Cost that does not change with the level of output (for example, building, equipment, salaries to a certain extent).
  • Variable cost: Cost that changes, depending on the amount of services delivered (for instance, pharmaceuticals and supplies).
  • Total cost: The sum of recurrent costs and annualized capital costs.
  • Average cost per unit: Total cost divided by the number of units produced (for example, cost per patient treated, per immunization given, per cure dispensed).
  • Marginal cost: The cost of producing or providing one additional unit.

Perform Sensitivity Analysis on the Conclusions

  • Sensitivity analysis measures how various assumptions made in the course of estimating costs and outputs affect the conclusions.
  • Sensitivity analysis deals with uncertainty in assumptions that underlie the analysis or with problems of imprecise measurement.
  • To guard against this possibility, systematic checklists (see Drummond et al. 2005) are helpful for critical review.