UNDERSTANDING COSTS OF GOODS AND PRICING FOR PDPs
May 21-22, 2014 | Population Council in New York
The fifth technical meeting of the PDP Access Steering Committee was held in New York City at the Population Council on May 22-23, 2014. Eight Product Development Partnerships (PDPs) including Aeras, DNDI, FIND, IAVI, IVCC, MMV, Population Council, TB Alliance and partners including UNITAID, USAID, and Global Health Technology Coalition (GHTC) attended the meeting.
The aims of the workshop were:
- To gain a better understanding of the basic principles involved in COGS, including the definitions, terminology, use, and value to PDPs
- To understand the fundamentals of product pricing decision making, including identifying basic variables used by suppliers and internal and external influencers
A summary of the discussions from the two-day meeting is below:
DAY 1 -
Session 1: Why do COGS matter?
PDPs have a mandate to deliver quality products at affordable and sustainable prices to ensure that the poorest populations have access to life-saving products. Pharmaceutical manufacturers, suppliers and other commercial parties are governed by different motivations, therefore, it is important for PDPs to understand these motivations, manufacturing drivers, and technology considerations to achieve agreement across all sectors and partners on affordable and sustainable prices for products in middle and low income countries.
Terminology, Use and Value of COGS: COGs is different than “product price” which is defined as the amount of money charged to customers for a particular product and which may vary for different buyers and regions. COGs is normally defined as the direct costs attributed to manufacturing the product for sale. Calculation of COGs may differ by company and may incorporate R&D, distribution and/or sales costs.
There are three manufacturing components that are calculated to determine COGs:
- Capital costs -Considered one-time costs, such as building laboratories
- Semi-variable costs -Product-specific costs, such as regulatory or labor etc…
- Variable costs -Costs that vary for each product such as raw materials consumables, and waste.
The complexity of the product manufacturing process is a key driver for COGs.
While it is valuable for PDPs to understand COGs to build the case for investment during R&D, or to better negotiate pricing terms, such as volume and distribution, it can be difficult to almost impossible to obtain. Such information is commercially sensitive and often proprietary. Price forecasting therefore is most often NOT related to COGs. More often than not, price setting is sensitive to the demands of the market including demand and supply. However, when competition is a major factor in the market, COGs can at times be more directly related to price.
Issues in manufacturing: PDPs and their manufacturing partners need to understand the same language when discussing or negotiating prices. PDPs need to understand and appreciate the high cost of bringing a product to the market including the frequent failure of products in development; manufacturers need to ensure an acceptable return on investment but remaining competitive at the same time.
The market value structure helps to influence the price based on several variables:
- product profile
- maturity of the market
- return on investment; including royalties
- marketing promotion and sales
- Phase IV trials, and
- operating costs
It is helpful to consider whether a manufacturer has received R&D funding, recouped R&D investment, and/or is operating at full plant utilization. These factors may indicate whether the manufacturer would be willing to lower prices or enter developing countries. Contract manufacturers in the developing world may be more willing to share data with the incentive of obtaining investment. The Global Fund keeps a database of COGs by compound, made possible because of data for off-patent compounds.
The markets that the PDPs work in are constantly evolving. Multinational pharmaceutical companies are now more willing than ever to work in a public health environment and emerging manufacturers are looking seriously at cost-effectiveness of new products. While industry is principally looking for the return on investment, reputation and corporate social responsibility are important and will influence decisions on whether to introduce products in the developing world. Expected rates of return are based on cost of capital, risk, franchise value, capacity, volume, and competition.
Session 2: Product pricing in public health: COGs and pricing principles of the Bill and Melinda Gates Foundation:
The Foundation is working to improve availability of vaccines and incentivize pharmaceutical companies to reduce prices, the Foundation provides:
- development costs to manufacturers
- facilitate procurement, and
- negotiate lower prices
A standard methodology exists to determine costs of several vaccines in a particular market to avoid the problem of manufacturers accounting for costs in different ways and to improve vaccine access and affordability in low-income countries, while allowing manufacturers to earn an appropriate return on investment. However standard methodology is difficult to implement because companies keep data in different ways.
Allocation keys are one way that are to help identify costs – including volume, revenue, time, square-footage, headcount, etc… for a specific vaccine in a certain market. The primary allocation keys used are volume and revenue. Revenue is difficult to evaluate in advance because volumes are difficult to estimate in the future, especially for GACVI countries. GAVI countries almost always require the most volume, but companies may be hesitant o invest there because of uncertainty in volume and price. When allocating costs, manufacturers often use “rules of thumb” that can lead to over- or under-allocation of cost.
A key variable of price is demand – low demand and low supply leads to high cost per unit, therefore it is necessary to generate adequate demand to increase supply and decrease prices. To address this, UNITAID aims to promote market conditions by creating incentives to invest, innovate and supply affordable quality public health products which yield little profit but substantial health benefits. UNITAID looks at a public health need and identifies access problems that are caused by market shortcomings – especially price – and has been able to consolidate demand for new products and negotiate bulk prices. In the case of second-line ARV medications UNITAID pooled demand, negotiated the price, and undertook a parallel project supporting the WHO prequalification program for manufacturers of the drugs. Over time, more suppliers and generics came into the market and costs decreased.
Product life cycle: The normal life cycle of public health products, vaccines or drugs, may be 8-20 years before the price will eventually decrease. COGs change over time depending on where the product is in the product-life cycle. In early development the analysis is based on the technical feasibility of bringing the product to market. During commercialization, COGs are focused on negotiations and production site selection. Once in the market, COGs may be used to demonstrate value.
COGs can be evaluated in simplistic or involved methods. The simplistic method includes direct costs and pre-determined overhead rates but do not reflect cost changes in the product life cycle. Involved COGS includes detailed overhead costs, variable costing, cost-volume relationships, and capital costs. Other considerations needed to determine market price are dependent on volume, such as the manufacturing site configuration, market structure, and procurement. There are also in-market risk premiums, working capital costs, and financing expenses, all of which are not included in COGS. Speed and efficiency in manufacturing can significantly reduce COGS.
External influences on COGS: There are many external influences on COGs including volume pricing, WHO agreements, market policies, health system infrastructure to name a few. For example, as the demand for long-lasting insecticide treated bed nets (LLIN) increased, additional suppliers appeared and the price decreased. The expiry of drug patents also leads to decreases in price as generic competitors enter the market, also the time needed to develop particular drugs and vaccines can also impact pricing and the market.
Donor pricing policies and practices influence product prices. Prices offered to countries can be based on income level and disease burden. Donors consolidate demand and pool procurement which generally reduces prices and they guarantee a future market.
Pricing policies are also challenging; there are several approaches:
- Cost-plus pricing – There are several variations of cost-plus pricing, but the most common method is to calculate the cost of the product, then add a percentage of the cost as markup. This approach sets prices that cover the cost of production and provide sufficient profit margin for the firm to reach its target rate of return. However this approach may limit incentives for manufacturers to increase efficiency or produce low-cost medicines
- External reference pricing – obtains a baseline from prices in different countries but this can create a cycle of referencing, making it unclear how a price is set
- Value-based pricing – makes decisions based on cost-effectiveness, but this requires more technical expertise, and can lead to prioritizing drugs of small benefit to large numbers of people versus large benefits to small numbers of people
Most high-income countries use mixed approaches to balance out the advantages and shortcomings of each approach. The choice in pricing strategy is very product-and country-specific, and the effect on other global market characteristics should be considered.
Discussions: Workshop members emphasized the importance of clear definition of COGs. Value and cost should be better linked, as the cost of R&D is not always equal to the value created. Additionally, delivery costs are currently not considered in discussions with countries but should be. There have been initiatives to measure delivery costs recently for vaccines and malaria medications and WHO has begun to educate countries on pricing strategies.
It was acknowledged that the quality of conversation with manufacturers has improved with Gates Foundation staff coming from a private sector background. But this does impact on the role of the PDP Access group, which needs to explain the value and expertise they bring to the table. Access negotiations with industrial and other funding partners should address COGs, with a focus on partnership and confidentiality to allay concerns about revealing COGs data. In general better information sharing is required: UNITAID and GHTC have both created tools which can be shared.
“When and how do we apply tiered pricing, social marketing, subsidized pricing, etc.?” is a common question posed by the PDPs. PDPs need manufacturers to acknowledge that they make profits in high-income countries, and that it is worthwhile to move into developing countries. Companies normally only wish to donate products unless there is a compelling need and often countries do not appreciate and cannot work within the donation model when they are given products close to expiry.
The final question debated was “How do we manage initial low volumes during launch of a product?” This was mostly answered using UNITAID’s model as a market catalyst. It can take a long time to switch standards of care with a new product and for new procurement practices to take shape. However, demand can be generated through consolidation, pulling procurement and creating larger volumes over time.
DAY 2 -
Final session: The workshop was presented with case studies illustrating how COGs affected negotiations and decisions before and after a product is developed, and ended with a presentation on USAID’s forthcoming toolkit for accelerated development, introduction and scaling up of new products.
 Agenda and complete list of participants and presenters can be found in Annex I of Meeting Summary