Volume Guarantees in Global Health and Economies of Scale : The Effect on Prices

Global-health buyers are increasingly using purchase volume guarantees (VGs) to lower prices for medicines, and increase access for low-income countries. One main driver for substantial price reductions associated with VGs are economies of scale (EoS). However VGs involve a trade-off across time: committing high future volumes today may negatively impact competition and new supplier entry in the future. We develop a two--period auction model to evaluate the impact of the size and the split of a VG among incumbent suppliers on current and future prices, when technology is mature and fixed production costs are high. First, we assume that suppliers behave in a myopic way, i.e., they ignore future procurement auctions. We then extend our analysis to (a) strategic suppliers that anticipate and incorporate future procurement auctions in their bidding strategy, and (b) the possibility that a new entrant joins in the future. We find that due to EoS second period bids, a proxy for future prices, do not monotonically increase in the guarantee. First round bids, a proxy for current prices, do not necessarily decrease in the guarantee, as one would intuitively expect. Interestingly, there may be benefit from splitting the current volume among suppliers in the presence of EoS. Strategic suppliers bid away future profits, hence their bids are lower when future procurement cycles are anticipated, and they are higher when new (low cost) suppliers are expected to enter the market. Our work provides insights into designing a long-term socially optimal procurement mechanism