When R&D is Bad for Patients : Strategic Price Control Under External Reference Pricing in the Presence of a Tactical Firm

Problem Definition: Healthcare expenditures are increasing worldwide, and spending on pharmaceutical drugs is a major contributor to this trend. Many countries are responding by implementing external reference pricing (ERP) to contain drug prices, which is a commonly used policy by countries such as France, Austria, and Finland. ERP sets a price ceiling for drugs based on the prices firms charge in other countries. Even though ERP's implementations have attracted attention from both industry and academia, past research has not considered the strategies a firm uses to counter ERP while studying its effects. For instance, firms can respond by raising prices in the reference country or by differentiating the product in the country where ERP is implemented to invalidate the reference set being used. Since such counter-strategies can potentially undermine the effectiveness of ERP, we address this gap in the literature to examine the trade-offs that arise in the strategic interactions among the government and the firms. Methodology/Results: We develop a stylized game-theoretic model to incorporate firms' counter-strategies and capture the interactions among the parties involved. Our analysis shows that: In the presence of ERP, patients can sometimes be worse off due to a firm's product improvement; and a firm can sometimes benefit from the tactical actions of a rival firm. We also show that bigger market size does not always lead to a stronger price control policy. Finally, we show that pharmaceutical expenditure may, in fact, sometimes increase due to ERP.Managerial Implications: The conceptual and managerial insights drawn from our research contribute to a better theoretical and practical understanding of strategic decision-making by the government in the presence of tactical firms. Our results can help governments to optimally plan and implement ERP policy in the country while accounting for counter-strategies by the pharmaceutical firms