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A9. Tendering for Medicines in New Zealand

The Pharmaceutical Management Agency Ltd of New Zealand (PHARMAC) is a not-for-profit company owned by the Health Funding Authority of New Zealand. Its role is to manage the national pharmaceutical schedule on behalf of the Authority.

The schedule is a list, updated monthly, of over 3,000 subsidised prescription drugs and other medical products available in New Zealand. The schedule records the price of each drug, the subsidy it receives from public funds, and the conditions under which it is funded. Upon dispensing a drug, a pharmacist is reimbursed the amount of the government subsidy and the patient pays the difference, if any, between the subsidy and the price.

The PHARMAC board makes decisions about what drugs to include on the schedule. In so doing, it seeks to balance the needs of patients for equitable access to medicine with responsible management of costs. Reimbursement to pharmacists is based on a reference pricing system by which the drugs are subsidised at the level of the cheapest therapeutic equivalent.

In 1996 and 1997, PHARMAC first implemented competitive tendering as a means of purchasing pharmaceuticals. Two suppliers dominated the generics market: Douglas, a local New Zealand company, and Pacific, a subsidiary of E-Merck. Generic prices were quite high, close to the prices of branded equivalents.

The New Zealand generics market has shifted within five years from one that could be characterised as high-price, low-volume to one that can now be characterised as low-price, high-volume. As a result of tendering, there is new competition for the generics market in New Zealand, which makes up 20-25% by volume of the total pharmaceutical market.

Tendering was first discussed in New Zealand in 1996. The first drug to be tendered was paracetamol, launched for a one-year experimental tender in 1996. In 1997, PHARMAC invited tenders for sole-subsidised-supply status for specific preparations of 23 chemical entities.

In response to the invitation to tender, suppliers offered to reduce prices if PHARMAC would defer the tender on specific chemicals. These reductions ranged between 20% and 60% less than the existing price of many products. By accepting these price-reduction proposals, PHARMAC was able to save NZ$18m (approximately £5.4m) in the first year. Through tendering the remainder of the chemicals, it was also able to save NZ$7m (approximately £2.1m) in the first year. In the second year of the initial tender, only one chemical was deferred for price reduction and NZ$25m (approximately £7.5m) was saved directly by tendering.

Price reductions resulting from tendering for sole subsidised supply in the first tender averaged around 39-40%*, with results exceeding PHARMAC's expectations.
*PHARMAC Annual Review for the year ending June 30th 1999.

Owing to the success of the first multi-product tender, in 1998 PHARMAC consulted on another, larger tender in markets worth approximately NZ$70m. Some proposed revisions to implementation from the previous tender were:

  • allowing suppliers to bid for preferred-brand status in addition to sole-supply status;
  • allowing suppliers to make bids involving more than one chemical;
  • increasing the length of the trade-in and trade-out periods to allow suppliers and pharmacists to manage stock more easily.

After evaluating consultation responses, PHARMAC entered into three contracts with suppliers which involved price reductions from March 1st 1999 for some products. In return, PHARMAC agreed to provide protection from tendering for a particular period. Price reductions from these contracts are estimated to save approximately NZ$4.7m per year.

PHARMAC tendered a subset of the products on the original consultation list in December 1998. Savings from this tender are expected to be approximately NZ$15m per annum, with subsidy reductions to occur in 1999/2000.

In 1998/99, PHARMAC managed a reduction in pharmaceutical expenditure by NZ$55m owing to major price reductions (up to 60 and 70%) for eight different medicines. According to the Annual Review, without PHARMAC interventions, the drug subsidy bill in 1999 would have been NZ$257m higher, and NZ$322m higher next year*.
*PHARMAC Annual Review for the year ending June 30th 1999.

A9.1 The tendering process

The tendering process is open to manufacturers and traders. In the first phase of tendering, PHARMAC identifies suitable candidate drugs. With the help of a medical evaluation board, drugs which are not suitable, such as those with a narrow therapeutic index, are eliminated from the tender. Also eliminated are drugs for which it is difficult to achieve sufficient generic competition (eg, hormone products), some of the larger asthma products, and niche products.

After the consultation period, during which a suitable group of drugs is chosen, PHARMAC issues the invitation to tender, which includes the terms of the contract. To encourage entry, it allows bids from unlicensed suppliers as well as those already licensed in New Zealand.

If the best bid is from an unlicensed supplier, the board will delay awarding a tender until an independent assessment of the licensing requirements has been made. The board will consult with the potential winner and instruct certain changes that need to be made to the dossier. If the potential winner is close to market approval, the board will sometimes announce the award of the tender before approval. In cases of uncertainty about approval, the importance of continuity of supply always takes precedence over lowest price.

After the invitation is released, suppliers are given two to three months to submit closed bids. Bids for sole-subsidised-supplier status must contain the ex-manufacturer price being offered, as well as supporting information to show that the supplier can provide security of supply (eg, previous supply record, location of the primary and alternative plant, source of active ingredients, etc). The winner of the bid is granted sole-subsidised-supplier status for community pharmacy prescription sales only. Hospital and OTC medicines are not included in the bid. Information about licensing must also be provided in the bid.

Evaluation of bids is based largely on price and continuity of supply, and evaluation is staggered, with the most important drugs in terms of cost savings processed first. In the first tender, it took approximately one month after receiving bids to decide the tender for 5-6 products, with 25 products being decided one month later, and the following 15 being decided a month after that.

The winner of the tender is announced to the market. A transition period is allowed so that suppliers and pharmacists can use up old stock and the winner of the tender can gear up for increased supply. Through the first two months after the announcement of the winner, the market continues as it did pre-tender. At the end of the two months, the tender price or subsidy comes into play. After four months, other suppliers are delisted from the schedule.

The design of the tender is such that potential suppliers are bidding for status of sole-subsidised supplier. There is no volume guarantee; rather, in the invitation to tender, PHARMAC gives the indicated total market size for a given drug preparation. Winning sole-subsidised-supplier status binds the supplier to three years of meeting total market demand, with no minimum or maximum volume determined. The supplier indemnifies the government in the case that an unexpected shock disrupts production or supply. In the case of such a shock, the government looks to other suppliers and the sole-subsidised-supply winner pays the difference.

The auction is sealed-bid, and results from the first tender show that suppliers have poor information about each other's costs. For example, in some cases, the best bid was an 85% price reduction versus the next closest bid of a 35% price reduction. The sealed bid is an attempt to keep as much information about bidders' costs secret so that there is less chance for collusion.

PHARMAC does not contract for distribution directly. Subsidies are based on the ex-manufacturer price and are paid by the government to the pharmacies after dispensing. There is a historically based notional wholesale mark-up of 10% and a retail mark-up of 3%, plus a dispensing fee. In the past, these mark-ups had been set at 10% and 11% respectively. This has been rebalanced, with more of the retail reimbursement now in the form of the dispensing fee.

A9.2 Effects on the chain

Overall, tendering made the market attractive for new players. According to PHARMAC and based on post-tender interviews with suppliers, winning a tender lowered the costs of the winner. Post-tender, they had a new, or larger, market share, were able to buy chemicals in bulk and exploit economies of scale in production, and, importantly, did not have to pay bonuses to pharmacists, which had previously dealt only with two, or possibly three, suppliers. New entrants were primarily local New Zealand traders and emerging suppliers from India and other parts of the world.

Before tendering, the two generics suppliers shared the market with multi-nationals which controlled approximately 60% of the market with branded drugs. After tendering began, the generics firms were willing to undercut the branded prices (ie, choosing high-volume, low-cost). As a result, the branded multi-nationals lost significant market share owing to the more competitive generic sector.

Pharmacists have not reacted smoothly to the announcement of tender awards. The demand for the sole-subsidised supplier's brand is very high from the first day of the announcement of the award. Owing to risk aversion, pharmacists do not want to have any other brand on their shelves as soon as the tender is announced. One resulting problem for the winning manufacturer is that demand shifts from perhaps 20-30% to 100% of market share from the first day of the tender award. To respond to this, a delayed announcement can be made in order to give the bid winner time to gear up stocks.

A9.3 Key design features

Two important features of the New Zealand tendering design are the allowance of bidding from unlicensed suppliers and the long length of time for the tenders. Regarding the length of the contracts, suppliers have reported in interviews that it allows them to offer lower prices as they can negotiate bulk purchasing of active ingredients and have the certainty of a long supply contract. However, most contracts have not yet been re-tendered. It remains to be seen whether a sufficient number of bidders will remain in subsequent rounds.

Allowing unlicensed bidders reduces barriers to entry. With relatively low entry barriers, incumbents with low costs cannot be sure that they will not be underbid by a new entrant. There is always a risk of delay, however, in the event that the new entrant's application will be problematic.

The contract design is made explicit in the invitation to tender. Thus far, tenders have been organised for individual preparations and for bundles across preparations of the same chemical entity. PHARMAC is currently considering bundling across different chemicals. In addition, it is exploring the idea of making tenders exchange-rate adjustable and allowing different prices for each year of the tender.

PHARMAC has experienced one major supply disruption. The successful bidder experienced manufacturing problems in product and a supply problem arose a year into the tender period. PHARMAC was able to obtain the supply that it needed from some of the other suppliers which had lost the tender, but had stock available.

A9.4 Costs and benefits

The costs of setting up the tendering system in New Zealand were relatively low because an existing framework was used. Therapeutic group managers already employed by PHARMAC participated in designing the tenders. The tendering scheme itself takes three full-time equivalents to run, with some services (eg, medical evaluation) contracted out. With regard to IT, nothing new was designed for the tender.

The benefits of the tendering process have thus far been promising, exceeding PHARMAC's expectations in terms of lowering prices. In terms of overall savings results, Table A9.1 below summarises savings from price competition in the off-patent markets in New Zealand since consultation on tendering began. The types of savings fall into three categories: sole-supply contracts, preferred-brand contracts, and tender-deferral contracts.

Table A9.1: Overall savings from price competition since the introduction of tendering in New Zealand

YearContract typeNumber of chemical entitiesAnnualised savings (NZ$m)
1997/98Tender deferral2018
 Preferred brand72
 Sole supply157
1998/99Tender deferral87
 Preferred brand715
 Sole supply4719
1999/2000Tender deferral41
 Preferred brand0 
 Sole supply13321
Total  90

Notes: Some chemical entities occur more than once (eg, some presentations of a chemical may be part of a tender-deferral contract, while other presentations of that chemical are part of sole-supply contracts, etc). 1 The savings for sole-supply contracts in 1999/2000 are savings as at mid-2000. Many of the same chemicals as in the 1997/98 tender-deferral contracts.
Source: PHARMAC.

Sole-supply contracts are awarded by tender and the winner receives the status of sole-subsidised supplier for a given drug preparation (or bundle of preparations of the same chemical) for a given period (generally three years).

Preferred-brand contracts were an experimental form of contracting, whereby pharmacists were required to dispense the preferred brand if they could legally substitute for the branded product (ie, if the prescription was written generically). Generic suppliers took a risk for this kind of contract and offered major price reductions, but market share has been small (ranging from about 20% to 50%), as branded suppliers responded by persuading doctors to prescribe by brand and use no substitution prescription pads*. None of these contracts was awarded in 1999/2000.
*This form of contracting is not generally recommended by PHARMAC. Although it has the advantage that stock shortages are less likely, prices ultimately tend to be higher.

Tender-deferral contracts resulted from consultations with suppliers after the invitation to tender for certain drug preparations. These contracts took the form of significant price reductions in return for PHARMAC agreeing not to tender particular drug preparations for a set period, usually two years.

For the 1997/98 tenders, weighted price reductions were around 40%. For the tender in 1999/2000, they were on average over 60%. Table A9.2 summarises some of the price reductions resulting from tendering certain preparations and shows how the New Zealand prices compare to those paid in the UK.

Table A9.2: Price savings for selected drug preparations as a result of tendering for pharmaceuticals in New Zealand

It should be noted that Table A9.2 gives results for some of New Zealand's most successful drugs. For example Baclofen (10mg), Isosorbide mononitrate slow release (240mg) and Metformin (500mg) posted best price reductions of 96%, 91% and 84% respectively compared to prices paid five years ago.

Prices paid by PHARMAC after tendering are significantly different from those paid in the UK, both in the hospital and the community pharmacy sectors. Table A9.3 shows the percentage difference between New Zealand prices and those paid in the UK community pharmacy and hospital sectors for the sample of drug preparations in Table A9.2.

Table A9.3: Difference (%) in prices paid in New Zealand and the UK for a sample of drug preparations

Drug preparation

% increase from New Zealand price to:
UK PCA priceUK hospital price
Baclofen (10mg)31018
Isosorbide Mononitrate slow-release (60mg)1728252
Metformin (500mg)9783
Tamoxifen (20mg)30067
Verapamil hydrochloride slow-release (240mg)992349
Amoxycillin capsules (250mg)502138
Amoxycillin capsules (500mg)404165
Ranitidine (150mg)83522

Note: PCA price used is less 11% claw-back. All prices converted to UK pence per unit (eg, tablet) and compared.
Source: OXERA analysis of data from the PCA, 1999, and PHARMAC.

Overall, the New Zealand move to centralised purchasing of pharmaceuticals has gone quite smoothly. In continuing to refine the system, PHARMAC is considering back-up supply contracts for important products. One possibility is to enter into a contract with Australian supplier, Hexalon, for 24-hour-notice emergency supply in times of crisis. Pacific provides back-up of its own through the E-Merck network.

The introduction of centralised tendering has led to a shift toward generics and a significant decrease in pharmaceutical prices in New Zealand. PHARMAC is pleased with its cost-savings success of 15-20% of ex-manufacturer expenditure thus far. However, the system is relatively new, and it will be interesting to see how tendering progresses in repeated rounds of bidding.

The manufacturing industry claims that there has been an exodus of direct investment in pharmaceuticals in New Zealand; however, aggregate data suggests there was no substantial pharmaceutical industry presence in the country in the early 1990s.

Beyond price reductions and the introduction of tendering, PHARMAC is also making demand-side initiatives to cut expenditure, such as promoting through workshops and publications the message of responsible (ie, cost-effective) prescribing to physicians, and confronting the increasing trend of direct-to-consumer advertising by manufacturers with its own educational campaigns*. It is estimated that total cumulative savings for decisions made between 1993 and 1998 regarding the introduction of tendering, demand-side initiatives and changes in the board structure have led to net savings of NZ$80m in 1997, NZ$123m in 1998, and estimated net savings of NZ$257m and NZ$322m in 1999 and 2000, respectively*.
*PHARMAC Annual Review for the year ending June 30th 1999.

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