NCPA - National Center for Policy Analysis


November 13, 2006

It is not obvious that allowing the government to negotiate with pharmaceutical companies will lead to lower prices than those achieved by private drug plans, say Alain Enthoven, a professor emeritus at the Graduate School of Business at Stanford University, and Kyna Fong, a doctoral student in economics.

Negotiations are a bargaining process.  The relative balance of bargaining power determines at which price the deal is struck.  People often confuse market power with bargaining power:

  • The thinking goes, the larger the share of the market the buyer represents, the greater the bargaining power and thus the lower the prices negotiated.
  • That line of reasoning fails with drugs, however, because the seller is frequently a monopolist so it cannot be threatened with replacement by a substitute.
  • Instead, the only threat is exclusion from the market.

Rather than market share, a party's bargaining power is determined simply by its ability to say no, to walk away from the table without an agreement.  Whether the government or a private drug plan has greater bargaining power is not clear.  Which can walk away more easily and declare that some brand-name drug will not be covered on the formulary?

  • Private plans like Kaiser or United are able to negotiate deep discounts with pharmaceutical companies precisely because of the plans' ability to say no -- the ability to include some drugs and to exclude others, allowing the market to judge the resulting formulary.
  • On the other hand, when the government negotiates, its hands are tied because there are few drugs it can exclude without facing political backlash from doctors and the Medicare population, a very influential group of voters.

Source: Alain Enthoven and Kyna Fong, "Pelosi on Drugs," Wall Street Journal, November 13, 2006.

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