Pricing and Promotional Decisions of a Drug Manufacturer with the Presence of a Price-Volume Agreement

Abstract

Physicians prescribe not only based on the health outcome and costs of a drug, but also based on their personal experience and preference for certain drugs. Thus, drug manufacturers invest a significant amount of promotional efforts to influence physicians, efforts including detailing, invited conferences, and sponsored research, etc. Since a third-party payer must pay for all claims for a drug that is covered by an insurance plan, the expense for the drug may be very high and uncertain. To control increasing drug costs and sales uncertainty, price-volume agreements have been proposed as a way to reduce the risk of higher-than-expected drug expenses. In such agreements, a drug manufacturer has to return a portion to the payer of sales exceeding a pre-specified volume threshold. In this paper, we investigated the drug pricing and promotional decisions of a drug manufacturer in the presence of a price-volume agreement under three different pricing scenarios. We found it not necessarily true that a high drug price or a high quality drug (with a high health benefit) reduces the manufacturer’s motivation to promote. We also found that the existence of a price-volume agreement may not increase the drug price, but it does help control the promotional effort. Although a negotiated price may be lower than the price set by the manufacturer, a negotiation may not always be preferred because the manufacturer’s profit is reduced by the negotiation and thus an agreement may not be reached under certain circumstances.