Tuesday, January 31, 2006

Why Drug Reimportation Can't Work

Drug reimportation is a hot idea these days. It doesn't work. Here's why.

Say you are a textbook publisher. You have a line of college textbooks that you produce. This is a complex and expensive process; you hire high-level scientists and academics to write the books, editors to fix their dreadful writing, fact-checkers to make sure it doesn't say "e=mc3", artists to create the thousands of diagrams and charts and pictures. You pay for printing and warehousing and distributing. You pay IT companies big bucks to maintain your catalog and run your online order system. In short, every textbook represents quite a large investment of resources on your part.

You sell these books for $65 apiece to university bookstores across America. You make decent money; some years you lose a little, most years you make a nice profit. All is well.

Then one day you get a call from a university in Australia. They've heard about your line of textbooks, which it turns out are better than the textbooks that they can print in Australia. The university wants to buy books from you. Hooray, you think. Now, the problem arises that the Aussies don't have as much money sloshing around their public university system as we do. There's no way, in fact, that they can afford to spend $65 per book. They can give you $30 per book, no more than that. You talk things over with your accounting folks, and they tell you: good news. It turns out that the marginal cost of producing another textbook and shipping it to Australia is $27.50. Selling books to Australia won't make you a fortune, but it will improve your bottom line somewhat without hurting your core business. Everybody wins, and so the freighters loaded with copies of "Sociology And You" start steaming for Perth.

Until one day you come into your office and on your computer screen there appears a web ad offering copies of "Sociology And You" for $45. You click on the ad, and it's a company in Australia that is buying the books from you wholesale, and then reselling them to American college students over the Internet retail.

Is this a problem? Well, it's not much of a problem if these folks are moving 10 books a week. It's a huge problem if they're selling 10,000 copies a day. As you're preparing to address this problem, you turn on the TV and hear presidential candidates saying that the high cost of textbooks in America is an outrage, and that what we need to do is reimport these books from Australia, where they're cheap.

But they're only cheap in Australia because you are selling them to Australia as a marginal, peripheral business. The main market for your product is the one subsidizing all the fixed costs of book production; those Aussie dollars are just a little bit of icing on the cake.

So what happens if the government follows through on its promise of cheap textbooks for everyone? Well, they pass a law making it legal and easy to reimport these books directly without tiresome Internet runarounds. Eager wholesalers line up to make a fortune on this book bonanza...only to discover that there aren't any books available from Australia. Why are there no books available from Australia?

Because you, not being a complete idiot, have stopped selling Australia textbooks for $30 apiece. Every book you sold to Australia would end up costing you a sale here in the US, and the US sales are where you make your margin. Since the Australian sales are jettisonable from the point of view of your core business, you jettison them to save what's important, the U.S. market.

Drug reimportation works the same way. The issues about safety and provenance are purely side issues. The core of the problem is an economic question: what does it cost to get this particular product? It may be that the price is different in one place than another. Price differentials do create a potential for arbitrage, but they don't create a reality that the lower price is somehow the right price, or that everyone can get the lower price. Attempts by government to get the lower price for everyone will simply end up removing the lower price option for the people who had it before.

All drug reimportation laws can do is hurt the availability of American pharmaceuticals in other countries. You won't sell textbooks to Australia when those textbooks are destroying your profit center in America; Pfizer isn't going to sell drugs to Canada if the Canadian drugs are going to destroy their profits here. It's as simple as that.

(This "classic" post is brought to you courtesy of my old archives and lack of time.)

5 comments:

Jolly Roger said...

Legislation that bans the biggest component of users from trying to get quantity price breaks works-to bankrupt the Government.

Neither answer is a good one.

flint cordoroy said...

Why even ship the books to Australia if they're going to be shipped back to the U.S.?

Drug prices are kept artificially high by drug companies using various methods. They'll change the concentration of active chemicals and get a new patent. The drug works the same as the old one, but they'll spend millions on advertising hyping the new one. At the same time they will continue getting millions of dollars in research grants and tax breaks.

Or they will simply change the carrier molecules, but which then break down into the same active chemicals as the previous version of the drug. File for a new patent, ect ect.

There's also the point about diminishing returns of quality assurance. If a marginal improvement in what is regarded as "quality" costs a premium to make, thus making the drug unaffordable for most people who "need" it, there is no point in such quality improvement. But it looks better on on the books and the financial reports.

emily1 said...

why should american college students with fewer government-supported educational benefits subsidize low textbook prices for students in other countries where college costs are heavily subsidized? what is wrong with the free market allowing college students in the united states to take advantage of lower textbook prices abroad?

a person who really supports a free market would expect the textbook companies to suck it up and adapt to new market conditions introduced by the internet instead of engaging in hand-wringing over the company's 'right' to static market conditions where american college students pay 20%-50% more than students abroad for the same textbooks.

pharmaceutical companies are not entitled to a captive american market. it is not the responsibility of americans to subsidize low drug prices for citizens of other countries. restricting the market in order to force the consumer to pay an artificially high price for what is essentially the same product is not supportive of open markets at all.

consumers do not exist to ensure the survival of companies. companies are supposed to make a profit by figuring out to meet the needs of consumers at a lower price than their competitors.

Christopher said...

Emily1, there is a clear utility to providing at least some copyright protection, and it's not related to any sense of entitlement. Strong-form free-marketeering may make nice slogans, but it makes building a research-based company impossible when patent protection is so easily circumvented.

Anyway, to stick with the analogy, unfortunately Australia has a copy machine to make "generic substitutes." So even if you stop selling your books to them, they have now stolen your core business. Nevermind that they can't produce a new edition next year -- you won't be able to either!

emily1 said...

Emily1, there is a clear utility to providing at least some copyright protection, and it's not related to any sense of entitlement. Strong-form free-marketeering may make nice slogans, but it makes building a research-based company impossible when patent protection is so easily circumvented.

i think you're confusing two separate issues -- patent violations and reimportation of drugs. this comment thread addresses the reimportation issue. if an american drug company sells a drug for 20% less in canada, why shouldn't an american be able to buy the same drug from a canadian pharmacy?

this is not the same as buying an illegally produced generic. the rise of the internet has changed the market and the way consumers shop. this is not strong form free market sloganeering. it's a statement of fact.