[Ip-health] HIF and bid auctions

[Sean Flynn]

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In response to my post about competition and price regulation, Hollis
and Pogge have reminded me that they intend to get to cost estimates
through a bid auction - a competition-based means to force suppliers to
bid their costs in a market. They don't call it an auction, but I think
that is the right term for the mechanism they are trying to use. It
allows firms to bid to supply the contract with the idea that the lowest
bid (reflecting the lowest cost estimate by any single firm) would win.
Except there is a hitch - the innovator can elect to supply the contract
at the lowest bid price,  even if it was not theirs.



This is also an area where the utility experience can lend some insight.



In the US we shifted many regulated price systems to supplier auctions
in the 90s. The idea was similar - that in a competitive auction firms
will bid their costs into the market in order to get the contract. In
some areas the result was amazingly pro-consumer. Where demand is
relatively restrained and suppliers are many, prices for supply at
auction dived far below the previous cost findings in the regulated
process - more evidence that it is difficult to get to true costs
through price regulation regimes.



But the experience also has a key counter example. The problem with
essential services is that they are essential. Demand does not tend to
drop very much when prices rise. And there often legal mandates (like
the right to health) that mandate states and other parties to purchase
the product even where prices become unreasonable. So when supply can
predict that demand will require them to be selected, at least in part,
to meet the contract, then they can hike prices without affected demand
much. In other words, they have market power in the auction.



Take electricity prices during the 2000 heat wave in California. When
the suppliers foresaw shortages - when they knew their bid had to be
accepted at least in part to meet demand -- they knew they could raise
prices without much restraint. (The buyers in these markets are
distribution utilities under a legal obligation to purchase the amount
they need). Electricity "cost" bids went from about $35 a wholesale unit
(I forget what the unit was) to over $10,000 for the same unit an hour
or day later.



This problem of not enough excess suppliers to exceed demand may be a
frequent and structural problem in patented essential medicines markets
- where almost be definition there will be limited or no actual
competition in the market.



If, for example, you did the supplier tender auction for first line ARVs
around 1998 or so, before broad entry by the Indian companies, the
innovators and Brazil would have bid around $3,000 or so, those being
the costs at the time. If you did the auction in 1996, I guess there
would just be the innovator companies so maybe they would just bid
$10,000/ year. There would be no other bidders.



Even with Brazil, since Brazil could not (and did not want to) supply
the world, the innovators could have bid higher and they would still get
at least a big piece of the contract, assuming you had a legal mandate
to buy the supply you needed to meet the global demand. The innovators
would have market power in the auction.



The second problem is with the right of first refusal for the
innovators, which I believe Jamie has commented on.



As I understand it, after the bid, even if they are not the low bid, the
innovator may elect to supply the contract at the price of the lowest
qualified bid. I have never heard of an auction with this kind of rule.
It is certainly not how electricity supply auctions are run. This would
seem to serve as a large counter-incentive for any non-innovator firm to
participate in the auction. It takes a lot of work to put together a
tender offer for a drug, especially if it is a new drug that the firm
does not already produce. Why would a firm enter that kind of process if
they can't get the contract with a low bid, unless their bid is so low
that the innovator will not match it?



In 1998-ish when the lowest price of ARVs was around $3,000, why would
cipla, Ranbaxy, et al work over the next decade to decrease their cost
of production just to submit bids into a process they would be unlikely
to ever win, even if they bid the lowest price?



How do we get a generic market for APIs if the innovators can have the
right to take any contract? We have been seeing efforts of innovators to
try to snuff out generic API markets by segmenting markets so that none
of the mid income countries can be supplied by the generic firm. Some
(including myself) think the reason is to prevent the generic firms from
gaining sufficient economies to force the global market for APIs lower.
(See the KEI gillead complaint).



How would you guard against predatory pricing in the first refusal
process - i.e. the innovator accepting a contract below their real cost
just to stamp out competition from being able to scale up and force
prices lower in the future as greater economies emerge? I assume such
action would remain illegal - or would the auction have a global
antitrust exemption?



If you can't fix these problems with an auction structure, then you are
back to trying to figure out real and reasonable costs. That is exactly
where electricity markets are now. States are re-regulating, auctions
have price caps and a lot of effort and tons of cash is being spent
trying to figure out how to get real competition in the markets (e.g.
with more transmission and big incentives for building new generation).
I am not sure what the parallel effort would be to perfect the essential
meds bidding market.



If you land back on the struggle to figure out real (not just bidded)
costs, then you are back in the problem I identified previously - how do
you design a cost investigator, and then a process to watch dog the
investigator to prevent capture.



I am not opposed to the effort to perfect a price investigation
personally. Indeed, I think we have to do it for drugs where no generic
competition may emerge to sufficiently signal what real costs are. What
is the cost of Fuzeon?



-Sean





PIJIP <http://www.wcl.american.edu/pijip/>

American University, Washington College of Law



Sean Flynn, esq.
Associate Director

Program on Information Justice and IP
Washington College of Law
American University
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