Executive Summary of Report of Supply of Pharmaceuticals in South Africa

This report is a companion to our report Pharmaceuticals in South Africa – an Enquiry, published in 2016. The earlier report focused on the retail of pharmaceutical products.

This report starts with their supply by manufacturers and importers. The report is necessarily technical, drawing on the disciplines of economics, law and pharmaceutical chemistry. Every effort has been made to make it comprehensible to readers who are not specialists in one or more of these fields.

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Structure of report

This report is structured as follows. A glossary of acronyms, terminology used in the analysis of pharmaceuticals and economic concepts. A summary of conclusions, serving as an executive summary, follows.

Section A sets out background information on the size of the pharmaceutical sector, establishes the framework for classifying pharmaceutical products, and presents key information on supply in the private and public sectors.

Section B considers the problem of market definition in the pharmaceutical sector, presents quantitative information about competition in the private sector and discusses the participation of manufacturers in the public sector.

Section C deals with competition, vertical integration and foreclosure. It starts with a discussion of theoretical issues. It goes on to discuss the interaction between regulation and competition in the South African context, attention being paid to the legal environment. Against the background of Sections A and B, it identifies features of the pharmaceutical industry relevant to competition and vertical integration and applies theory to them.

Section D deals with cross-ownership and cross-directorships in the pharmaceutical sector. It indicates why these issues are relevant to competition, sets out the limits of available information and analyses the extent of cross-ownership and cross-directorships.

Section E sets out the legal framework governing the pharmaceutical industry and presents two case studies: one of vertical integration and the other of a horizontal merger. It considers representations made by the Independent Community Pharmacies Association about anticompetitive structures. The analysis is complex. To facilitate comprehension of the components of the analysis, the structure of each section is presented in summary form at the beginning of each section.

Conclusions from study

The conclusions from this study can be summarised as follows:

  1. The output of pharmaceutical industry supplying both the private and public sectors is estimated at R 48.6 billion in 2017. 69% is absorbed by the private sector and 31% by the public sector. Since most South Africans rely on the public sector, the per capita expenditure difference between the private and public sectors is large. This difference is partially offset by the fact that, compared with manufacturers prices in the private sector, the prices at which medicines are supplied to the public sector are much lower.
  2. There are 174 manufacturers in South Africa. 95 of them supply exclusively to the private sector, 15 exclusively to the public sector and 64 to both sectors.
  3. The variety of products sold in the private sector is much greater than in the public sector. In part, this reflects the differential basis for competition in the two sectors. In the private sector, manufacturers compete by offering their full range to the market. In the public sector, acquisition is by tender, so the competition has taken place before the products are made available to consumers. Even so, the number of active ingredients available in the private sector is two and half times the number available in the public sector.
  4. There are 267 ATC 3 categories. At least one medicine is available in 201 of them in the private sector, and 138 of them in the public sector. Public sector availability is slightly under-estimated because of incompleteness in the ATC coding in the MPL.
  5. 53% of the identicals supplied to the private sector contain only originator medicines, 33% contain only generic medicines and 14% are a mixture of the originators and generics. Accordingly, there is a consumer choice between originators and generics only in respect of a small minority of medicines. However, the fact that a third of identicals contain only generic medicines is an indication of how competitive generics are in the South African market.
  6. Five-eighths of total public sector expenditure is concentrated in ATC 1 Category J (Anti-infectives for systemic use), which includes anti-retroviral medicines for HIV infection, vaccines and medicines to treat tuberculosis. Anti-retrovirals and vaccines alone account for just over half total public expenditure. By contrast, medicines to treat tuberculosis, diabetes and epilepsy account for just over 8% of total public expenditure. The absence of expenditure data in the MPR makes it impossible to compare the concentration of expenditure in the private and public sectors.
  7. There is not just one market for pharmaceutical products, but many. There are several criteria for market definition in the pharmaceutical sector and the relevance of each of them will vary from case to case. Accordingly, it is difficult to generalise, but it is clear that monopolies, monopolistic competition and oligopolies are widespread in the private sector. Even within identical classes perfect price competition is uncommon.
  8. Five manufacturers have more than 200 products registered on the MPR for sale in the private sector: Pharmacare (607), Adcock Ingram (401), Sandoz (338), Cipla Medpro (223) and Pfizer (219).
  9. Six manufacturers supply more than 40 products to the public sector. They are Pharmacare (106), Fresenius Kabi (63), Cipla Medpro (58), Sanofi Aventis (55), Adcock Ingram Critical Care (52) and Gulf Drug Company (42). Seven manufacturers each provide medicines worth more than R500 million to the public sector. They are the Biovac Institute (established in 2003 as a public-private partnership to import, export, package, test and distribute vaccines), Pharmacare, Mylan, Sonke Pharmaecuticals (established in 2006 as a Black Economic Empowerment joint venture between Ranbaxy and Community Investment Holdings), Cipla Medpro, Sanofi Aventis and AbbVie.
  10. The current approach to the competitive effects of vertical integration is to enquire whether they lead to input foreclosure or customer foreclosure. Input foreclosure means that downstream retailers are foreclosed from buying from a particular upstream supplier. A situation in which a retail pharmacy is unable to purchase a product from a manufacturer, either directly or through a distributor, or from a wholesaler is a case of input foreclosure. Retail pharmacies will be concerned about input foreclosure. Customer foreclosure means that an upstream supplier is foreclosed from selling to a particular retailer. A situation in which a manufacturer is unable to sell a product to a retailer, either directly or through a distributor, or to a wholesaler is an instance of customer foreclosure. Manufacturers will be concerned about customer foreclosure.
  11. The pharmaceutical sector is heavily regulated, in part for reasons common to all countries and in part as result of establishing the Single Exit Price system. However, the SEP system is less rigid than it might first appear. The system depends completely on initial prices proposed by manufacturers. Proposals may be accepted or rejected by the Department of Health, but they cannot be amended by it. The regulation of the income stream for wholesalers and distributors is defined by product. It cannot vary between wholesalers and distributors for a particular product, even though wholesalers assume the risk of ownership whereas distributors do not, and it cannot reflect differences in cost, occasioned for instance by scale of operations or geographical location. Pragmatic adjustments have to be made in order for the system to be workable.
  12. Logistics fees as a percentage of the SEPs vary widely: the median is 10% with half of the observations falling between 7.4% and 12.5%. There are differences in the logistics fee as a proportion of the SEP within identical groups where there are two or more manufacturers. The manufacturer’s offer of a logistics fee will reflect its view of what is needed to make the product competitive in respect of retail pharmacy purchases. An analysis of the 100 manufacturers supplying at least ten products to the private sector shows that in fifteen cases the logistics fee as a percentage of SEP does not vary across products offered. The remaining 85 manufacturers vary the logistics fee as a percentage of SEP by product. It is not evident why average logistics fees by manufacturer vary as widely as they do.
  13. Competitive conditions exist at the retail level. The two largest corporate pharmacies, Clicks and Dis-Chem, account for roughly 20% each of sales to the private sector, so that neither of them meets the 35% threshold defined in the law concerning abuse of dominance. Retailers can and do compete by setting dispensing fees at different level, subject to regulated maxima. In this, they are influenced by the terms that medical aids offer in return for designation as preferred suppliers.
  14. Exclusive dealing by manufacturers of generics is reported not to take place, so that neither input nor customer foreclosure takes place in the absence of vertical integration. There are also no incentives for foreclosure in the cases of two levels of vertical integration between (a) manufacturers and wholesalers/distributors and (b) wholesalers/distributors and retail pharmacies. There is a risk when all three levels are vertically integrated.
  15. While price is a major determinant of purchase by retail pharmacies, it is not the only one. The formularies of medical aid schemes often has an influence. Quality of service in respect of products and continuous availability also matter.
  16. Cross-ownership and cross-directorships may affect competition through facilitation of exchange of commercially sensitive information, ability to influence the decisions of separate firms and change of incentives facing management. Many firms at all three levels of the pharmaceutical industry (manufacture, distribution and retail) are privately owned and do not publish annual reports. Requesting information on them through the Companies and Intellectual Property Commission is impractical. Moreover, information on the levels of the pharmaceutical industry often cannot be separately identified within listed company reports.
  17. From the information available to us, we would assess cross-directorships in the pharmaceutical industry as very limited, indeed possibly non-existent. As far as cross-ownership is concerned, we believe that there are gradations in the likelihood that different forms of cross-ownership will result in anti-competitive conduct. Partial ownership by the Public Investment Corporation is ubiquitous in listed companies throughout the pharmaceutical industry, as it is elsewhere, but it is difficult to imagine the PIC using its cross-investment to promote anti-competitive behaviour in the pharmaceutical industry. Similarly, cross-ownership by unit trusts and similar investment funds, while certainly conditioned by the profitability of the companies in which they invest, is unlikely to result in anti-competitive behaviour. Were cross-ownership and crossdirectorships to coincide, there would be a risk of anti-competitive behaviour, but we have not been able to uncover a single case of this in the pharmaceutical industry.
  18. Two case studies, both concerning mergers and acquisitions by New Clicks Holdings Limited, are considered from a legal point of view. The first deals with the formation of the Unicorn, UPD and Clicks retail nexus, which involved a merger between Clicks Pharmaceutical Wholesale (Pty) Ltd and New United Pharmaceutical Distributors resulting in UPD becoming a wholly owned subsidiary of New Clicks. Unicorn Pharmaceuticals was not acquired through merger, since it was formed by New Clicks itself. The second case study deals with the merger between Clicks and the retail portion of Netcare’s Medicross pharmacies and it examines the reasoning of the Competition Commission and Competition Tribunal in detail.
  19. In terms of the second case study and other similar orders handed down by the Tribunal, it has become clear that the consideration employed before approving a merger is based purely on the Competition Act. Neither the Commission nor the Tribunal takes industry-specific law into account when making an order. The effect of a Tribunal order is different to a normal order of court insofar as it serves as a “clearance certificate” of sorts – that there are no restrictive practices at play between the merging parties which would render the merger uncompetitive. The order thus does not prevent alternative legal challenges to ownership, licensing or merger questions.
  20. Moreover, the Tribunal can only take decisions based on the current situation. The Tribunal does not project growth when considering the impact on competition. Should an anti-competitive situation arise after the Tribunal has taken a decision, that situation would have to be dealt with in a separate legal process.
  21. The information placed before the Commission and subsequently the Tribunal comes primarily from the merging parties themselves. This leaves a gap in terms of pertinent information which the Tribunal should be mindful of when approving a merger. The Commission does afford objecting third parties a chance to make representations during the investigations. The absence of industry regulators enables the Tribunal to act in such a limited capacity. Were such bodies to play a more proactive role alongside the Commission and Tribunal, questions of law which arise from legal instruments other than the Competition Act may play a more prominent, and consequently more instructive, role in the Commission’s findings and Tribunal’s decisions.
  22. To illustrate further the difficulties in application of the law, the report contains an account of a meeting between the Independent Community Pharmacy Association and the Minister of Health in October 2016, in which competition issues in relation to Clicks were discussed.