Most-favored Customer Research Articles

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

Using a difference-in-difference approach, we find that an increase to Medicaid’s minimum drug rebate under the Affordable Care Act in 2010 lowered non-Medicaid drug spending by 2.5 percent. A stylized bargaining model shows that this is likely driven by the interaction of this reform with Medicaid’s “most-favored customer” clause (MFCC). By examining the response of drugs that faced a change in incentives equivalent to the removal of Medicaid’s MFCC, we estimate that removing the Medicaid MFCC would have reduced overall 2010 non-Medicaid drug spending by an additional 3.5 percent, though it would have likely also increased Medicaid spending. (JEL C78, H51, I18, I38, L65)

플랫폼 최혜소비자 대우 조항의 후생 효과

본 연구는 어떤 경우에 플랫폼이 MFC(most-favored-customer) 조항을 사용하는지와 이 조항의 사용이 사회후생에 미치는 영향에 대해 분석한다. 이를 위해 서비스 품질에 차이가 있는 두 플랫폼에 서 두 기업이 경쟁하는 상황을 고려한다. 분석 결과, 두 플랫폼 간 경쟁이 치열하거나 경쟁 정도는 중간이면서 두 플랫폼의 서비스 품질 차이가 작은 경우 MFC 조항은 서비스 품질이 높은 플랫폼에 의해 사용된다. 그리고 MFC 조항이 사용되면 두 기업의 이윤은 감소하지만 소비자잉여는 증가하고, 소비자잉여의 증가가 기업 이윤의 감소보다 커서 사회후생은 증가한다.

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

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.

The ACA Medicaid Rebate Rule Change: Impact on Pricing and Innovation

Using a difference-in-difference approach, we find that an increase to Medicaid’s minimum drug rebate under the Affordable Care Act in 2010 lowered non-Medicaid drug spending by 2.5 percent. A stylized bargaining model shows that this is likely driven by the interaction of this reform with Medicaid’s “most-favored customer” clause (MFCC). By examining the response of drugs that faced a change in incentives equivalent to the removal of Medicaid’s MFCC, we estimate that removing the Medicaid MFCC would have reduced overall 2010 non-Medicaid drug spending by an additional 3.5 percent, though it would have likely also increased Medicaid spending.

Entry under uncertainty: Limit and most-favored-customer pricing

In the absence of uncertainty, an incumbent that attempts to prevent entry of rival firms can have no incentive to offer a most-favored-customer (MFC) clause because it could lead to higher post-entry prices. Our analysis suggests that this is not necessarily the case under uncertainty. In the presence of uncertainty, the incumbent can set a limit price that affects the entry decision. Limit pricing involves a pre-entry price different from the static monopoly price, which leads to a signaling cost. We show that part of this cost can be distributed over several periods by means of consumer refunds from the MFC clause. If the discount factor is not very high, the incumbent adopts this pricing and prevents entry to a larger extent.

Most-favored-customer pricing, product variety, and welfare

Most-favored-customer (MFC) clauses are usually seen as anticompetitive co-ordination devices that firms adopt for the purpose of higher prices. Here, I examine the welfare impact of MFC clauses under endogenous product variety. Product variety is relevant because prospective higher prices from MFC clauses can be anticipated by multi-product firms in their provision of product lines. Under such circumstances, I find that these clauses can be socially harmful, but this is not always the case: they tend to be socially neutral for relatively large fixed costs of product-line assortment, harmful for intermediate costs, and beneficial for relatively small costs.

THE EFFECT OF MOST-FAVORED CUSTOMER CLAUSES ON PRICES*

We study the effects of introducing a Most-Favored Customer (MFC) clause on price competition among major consumer electronics retailers. Our data spans the periods before and after the introduction of an MFC clause by Best Buy, which occurred between April 1, 2003 and March 31, 2004. After controlling for various factors (including product life-cycle and seasonality effects), we find that, on average, Best Buy lowered its prices by 1.6% after introducing the MFC clause. Its competitors responded by cutting prices further: Buy.com by 3.5%, Circuit City by 2.2%, CompUSA by 3.2%, and Sears by 0.4%. We conclude that Best Buy's MFC adoption reduced prices.

The Effect of Most-Favored Customer Clauses on Prices

We study the effects of introducing a Most-Favored Customer (MFC) clause on price competition among major consumer electronics retailers. Our data spans the periods before and after the introduction of an MFC clause by Best Buy, which occurred between April 1, 2003 and March 31, 2004. After controlling for various factors (including product life-cycle and seasonality effects), we find that, on average, Best Buy lowered its prices by 1.6% after introducing the MFC clause. Its competitors responded by cutting prices further: Buy.com by 3.5%, Circuit City by 2.2%, CompUSA by 3.2%, and Sears by 0.4%. Our empirical results are robust to a variety of measures and estimation methods. We conclude that Best Buy's MFC adoption reduced prices in the consumer electronics retail industry.

Monopoly Pricing Under a Medicaid-Style Most-Favored-Customer Clause and its Welfare Implication

To control Medicaid’s increasing expenditure on reimbursement of outpatient prescription drugs, the Omnibus Budget Reconciliation Act of 1990 included a rebate program that featured a most favored customer (MFC) clause. This clause guarantees that Medicaid gets a fixed rebate on each unit of purchase by Medicaid consumers. The rebate is calculated as the difference between the minimum price and the average manufacturer price (minimum price provisioning or MPP) or a proportion of the average manufacturer price (average price provisioning or APP). We characterize the optimal pricing strategy of a third-degree price discriminating monopolist in response to the imposition of MPP or APP rules. Under MPP, the minimum price gross of rebate always increases whereas prices gross of rebate in at least some of the markets always decrease. In contrast, under APP, these prices may move in the same direction in all markets, with all increasing in some circumstances and all decreasing in others. We also examine the effects of such provisions on social welfare and provide some useful sufficient conditions for directional changes in social welfare. For example, imposing MPP increases social welfare if it results in higher aggregate demand. Beyond the Medicaid setting, minimum price policies are relevant in a number of applications, including external referencing in drug pricing, price protection in long- term trading contracts and shifts of consumers between markets. We analyze a modified version of our Medicaid MPP model suitable for such settings.

The Strategic Response by Pharmaceutical Firms to the Medicaid Most- Favored-Customer Rules

In 1991 a most-favored-customer (MFC) rule was adopted to govern pharmaceutical prices paid by Medicaid. Theoretical models show that an MFC rule commits a firm to compete less aggressively in prices. I find that the price of branded products facing generic competition rose (4% on average). Brands protected by patents did not significantly increase in price. Generics in concentrated markets should display a strategic response to the brand's adoption of the MFC; I find that generic firms raise price more as their markets become concentrated. Hospital prices show little change. The results suggest that the MFC rule caused higher prices for some pharmaceutical customers.

Most‐Favored‐Customer Clauses and Multilateral Contracting: When Nondiscrimination Implies Uniformity

DeGraba and Postlewaite (1992) show that the seller of a durable input can solve the time inconsistency problem by offering most‐favored‐customer (MFC) protection to buyers. McAfee and Schwartz (1994) show that if a supplier sells inputs to competing firms using two‐part tariffs, MFC protection that allows a firm to replace its contract with a contract executed by any other firm will not solve the commitment problem, and argue this implies managers cannot use MFCs as a strategic commitment device in complex contracting situations. This paper shows that if the profits of the seller and the buyers are monotonic in each term of the contract, then applying MFC protection to each term of a contract allows a manager to solve his commitment problem in complex contacting situations. We show that “standard” contract arrangements (two‐part tariffs, declining block tariffs, and royalties as a percentage of sales) meet this condition.

Equilibrium incentives for most-favored customer clauses in an oligopolistic industry

This paper analyzes the economics of contemporaneous most-favored customer clauses (MFCC) in a non-cooperative n-firm oligopoly. In the first stage of a two-stage game, each firm independently decides whether to adopt MFCC; in the second stage, firms set prices non-cooperatively, given the first stage choices. In contrast to work on retroactive MFCC by Cooper [ The RAND Journal of Economics (1986, 17, 377–388)], our analysis shows that not adopting MFCC can be a dominant strategy. The difference between our results and Cooper's highlights important differences between retroactive and contemporaneous MFCC and suggests that MFCC are a less powerful facilitating practice than retroactive MFCC. Our analysis also sheds new light on Grether and Plott's [ Economic Inquiry (1984, 22, 497–507)] experimental results regarding the effects of MFCC on average industry prices.

Bilateral Most-Favored-Customer Pricing and Collusion

In a two-period differentiated products duopoly model, most-favored-customer (MFC) pricing policies allow firms to commit to prices above the Bertrand prices. It is shown here, however, that unless a restrictive and unappealing assumption is made about demand, there is no equilibrium in which both firms adopt MFC policies. The restrictive assumption is that at least one firm's demand is more responsive to changes in its opponent's price than to changes in its own price; otherwise, firms have an incentive to deviate from a greater-than-Bertrand price in the first period.

Facilitating Practices: The Effects of Advance Notice and Best-Price Policies

Even if firms in a market choose discount prices noncooperatively, the use of most-favored customer and meet-or-release contracts enables those firms to adopt quantity-choice strategies. Consequently, there can be a range of list prices that are impervious to unilateral nonselective discounts, but this range does not include prices above the level determined in a Cournot equilibrium. The practice of advance public notification of list-price increases can facilitate the establishment of such supracompetitive list prices, as was argued in the recent FTC Ethyl case. The possibility of offering discounts selectively results in a much more competitive situation.