Grey Markets Get a Shot of Clean Air

Grey markets caused by parallel importing create challenges for companies.  For some, parallel importing improves revenues.  For many, it is a challenge that can be ignored.  Yet for others, parallel importing presents a real pricing challenge.  On 16 September 2008, the European Court added a new arrow in the quiver for managing these types of grey markets.

If a product is sold in two regions at two different price levels, parallel importing occurs when products sold in the low priced region end up being imported into the high priced region, thus dampening sales in the higher price region but potentially increasing volume overall.

Sales through parallel importing are at times a fiscal boon surrounded by legal challenges.  For example, consider tobacco.  While a pack of cigarettes in neighboring countries (or states in the US) might have the same pretax price, consumers will pay different after tax prices.  As a result, customers have an incentive to purchase excess tobacco in European countries with a low tax on tobacco and resell their surplus in higher tax countries.   (Similar effects can be seen with Chicagoans and New Yorkers importing America’s first ready-for-export cash crop from neighboring cities and states.)  While the tobacco companies don’t encourage such action, the lower taxed areas do help profits by increasing sales volume overall as customers take advantage of buying more tobacco at an overall lower taxed price.

For many companies however, parallel importing is not a result of differing government tax levels, but rather corporate policy that encourages differential pricing.  When government bodies are not taking the hit of tax revenue losses from parallel importing, the companies themselves are taking the hit of revenue losses.

GlaxoSmithKline PLC, a UK based pharmaceutical firm, markets numerous formularies throughout the world.  In most countries, the price of a formulary is negotiated between Glaxo and the host country directly, resulting in different prices in different countries for otherwise similar goods.  For instance, Lamictal, an epilepsy drug, sold for € 0.81 in Greece and € 2.16 in Germany.  In this instance, Greek importers of low priced pharmaceuticals have a clear incentive to re-export their product to higher priced countries and pocket the price differential.  Moreover, European law rules that goods should be freely traded between member countries.  For Glaxo, the resulting parallel imports are a direct revenue loss, or restated, a failure to capture value in proportion to that created in developing, manufacturing, and marketing a highly valued product.

Recently, the European Court ruled that Glaxo can limit sales in some countries to “ordinary” levels, a ruling that goes against the general antitrust law of the EU that forbids dominant suppliers from refusing to supply products in an attempt to squelch competition.  One interpretation of “ordinary” would imply that Glaxo can limit the delivery of a pharmaceutical to the number of prescriptions for that particular formulary in that particular country.  If this is what “ordinary” is eventually ruled to imply, Glaxo’s parallel importing challenge will be greatly reduced.

Most firms however don’t have clear signals that a product is being imported into a low priced region for resale into a higher priced region.  Identifying parallel importing for most companies requires a bit more statistical work.  In each case, the challenge is to identify the level of true demand separate from the level of sales in a specific country, and then limiting sales to match the true demand.   Separating true demand from sales levels is a difficult task.

As an alternative to isolating true demand from sales levels and following through with limiting sales, companies can manage their differential pricing practices to curb incentives for parallel importing.  Parallel importing is created through financial incentives. Removing the financial incentives removes the parallel imports.  While differential pricing may improve revenues in the absence of parallel importing, it can harm revenues in the presence of parallel importing.  Thus, companies should limit their differing prices between countries to a level that would fail to provide profits to an unscrupulous buyer and otherwise parallel importer.

Which approach to take? Measuring true demand and limiting sales or managing inter-country price differentials to be less than that which would incent most parallel importers? To relieve this headache, try taking two aspirins and call the mathematician in the morning.

References

Charles Forelle, “Europe Allows Companies to Limit Drug Sales”, the Wall Street Journal, September 17, 2008. (Retrieved from WSJ.com on September 17, 2008)