A Fly in the Ointment…
Posted: August 10, 2012 Filed under: behavioral economics, cognition, game theory 4 CommentsAn article in today’s New York Times highlights a dramatic increase in the price of generic ointments over the last few years — generics have gone up 6 to 7 times their 2008 prices. 
Here is a chart showing the climb in prices for a few products. Before you say, this is clearly fallout from the new healthcare law, the article doesn’t point to any change in legislation covering ointments. In fact, there is a certain amount of puzzlement over why prices have gone up so much.
They note that doctors are not price sensitive when they write prescriptions and patients do what doctors recommend — that’s nothing new.
It turns out that regulation for generic skin treatments is more stringent than other generics because they must demonstrate that products are absorbed as well as the original treatments. This, more costly process creates higher entry barriers for generic ointments leaving three main players in the market — Perrigo, Taro and Fougera, which was recently acquired by Sandoz, the generics division of Novartis.
Ok, so its an oligopoly. However, this has been the case for quite some time. That in itself doesn’t explain why it resulted in price increases now since the market structure has not changed recently. Why now?
This seems to be a question best answered by strategy scholars since it goes well beyond the market structure. It is not obvious that the payoffs to each party have changed except that they realized that they can raise prices without losing customers to rivals. That sounds like a systematic shift in managers’ perceptions of the market structure more than a shift in actual market structure or real payoffs. Admittedly, this may have been spurred by some M&A activity in the market — the players have changed a bit.
Interestingly, the article does not point to Novartis’ recent entry as a factor. Of course, that may have entered because they saw the potential of the oligopoly structure in the market or the price increases may have already been under way. Now a shareholder dispute rages over Taro as the stakeholders disagree how long the elevated pricing will last.
Recent research into cognition and markets would seem to be informative. Perhaps one day, regulators will actually draw on it…
StrategyProfs.net 
[…] A recent blog post, along with a related New York Times article, outlines a dramatic increase in the price of generic ointments. Several factors might account for high prices including: […]
Some of the supergame models with uncertain/cyclical demand generate mixed strategy equilibria characterized by tacit collusion randomly interrupted by price wars. The price path in such an equilibrium would therefore have both low-price and high-price phases.
Models like that don’t encompass the effect of “contextual” factors like M&A causing ownership shifts, but you could imagine that it pays in an oligopoly to occasionally try raising prices to see whether rivals follow. A new owner might be most prone to such an exploratory stab. One critical factor (often overlooked in my opinion) is the relative observability by customers versus rivals to price changes. If customers react much more quickly than rivals, price wars and discounting are more likely; if rivals react more quickly than buyers, then price stability with the occasional upward stab in hopes of attracting followers are more likely.
The $4 taro ointment mentioned in the article is now over $100 at most pharmacies, including Target according to goodrx price comparison.
[…] A recent blog post, along with a related New York Times article, outlines a dramatic increase in the price of generic ointments. Several factors might account for high prices including: […]