Profiting from Most-Favored Customer Procurement Rules: Evidence from Medicaid

Abstract

We exploit a 2010 reform to Medicaid drug reimbursement to provide empirical evidence that “most-favored customer” clauses (MFCC) in procurement rules can increase private-market prices and profits, even when suppliers have significant market power. Under a bargaining model, Medicaid's MFCC creates a credible threat point that drug manufacturers exploit to negotiate smaller discounts with private payers. Using novel data on estimated discounts and a difference-in-difference framework, we show that the reform, which reduced the scope of the MFCC constraint, led to higher discounts and lower profits in non-Medicaid segments for drugs with high exposure to Medicaid.