Pharmaceuticals and SA – Supply
19 November 2020
This brief considers the role of manufacturers and importers in the provision and apparent distribution of pharmaceuticals.
THE SUPPLY OF PHARMACEUTICALS
In 2018 the HSF released the Report of Supply of Pharmaceuticals in South Africa (“Report”). In the Executive Summary conclusions regarding the findings were noted. For present purposes the following conclusions are worth noting:
There are 174 manufacturers in South Africa. 95 of them supply exclusively to the private sector, 15 exclusively to the public sector and 64 to both sectors.
It is clear that monopolies, monopolistic competition and oligopolies are widespread in the private sector. Even within identical classes perfect price competition is uncommon.
The current approach to the competitive effects of vertical integration is to enquire whether they lead to input foreclosure or customer foreclosure. Input foreclosure means that downstream retailers are foreclosed from buying from a particular upstream supplier. A situation in which a retail pharmacy is unable to purchase a product from a manufacturer, either directly or through a distributor, or from a wholesaler is a case of input foreclosure. Retail pharmacies will be concerned about input foreclosure. Customer foreclosure means that an upstream supplier is foreclosed from selling to a particular retailer. A situation in which a manufacturer is unable to sell a product to a retailer, either directly or through a distributor, or to a wholesaler is an instance of customer foreclosure. Manufacturers will be concerned about customer foreclosure.
The pharmaceutical sector is heavily regulated, in part for reasons common to all countries and in part as result of establishing the Single Exit Price (“SEP”) system. However, the SEP system is less rigid than it might first appear. The system depends completely on initial prices proposed by manufacturers. Proposals may be accepted or rejected by the Department of Health, but they cannot be amended by it. The regulation of the income stream for wholesalers and distributors is defined by product. It cannot vary between wholesalers and distributors for a particular product, even though wholesalers assume the risk of ownership whereas distributors do not, and it cannot reflect differences in cost, occasioned for instance by scale of operations or geographical location. Pragmatic adjustments have to be made in order for the system to be workable.
Competitive conditions exist at the retail level. The two largest corporate pharmacies, Clicks and Dis-Chem, account for roughly 20% each of sales to the private sector, so that neither of them meets the 35% threshold defined in the law concerning abuse of dominance. Retailers can and do compete by setting dispensing fees at different levels, subject to regulated maxima. In this, they are influenced by the terms that medical aids offer in return for designation as preferred suppliers.
While price is a major determinant of purchase by retail pharmacies, it is not the only one. The formularies of medical aid schemes often has an influence. Quality of service in respect of products and continuous availability also matter.
Cross-ownership and cross-directorships may affect competition through facilitation of exchange of commercially sensitive information, ability to influence the decisions of separate firms and change of incentives facing management. Many firms at all three levels of the pharmaceutical industry (manufacture, distribution and retail) are privately owned and do not publish annual reports. Requesting information on them through the Companies and Intellectual Property Commission is impractical. Moreover, information on the levels of the pharmaceutical industry often cannot be separately identified within listed company reports.
Two case studies, both concerning mergers and acquisitions by New Clicks Holdings Limited, are considered from a legal point of view. The first deals with the formation of the Unicorn, UPD and Clicks retail nexus, which involved a merger between Clicks Pharmaceutical Wholesale (Pty) Ltd and New United Pharmaceutical Distributors resulting in UPD becoming a wholly owned subsidiary of New Clicks. Unicorn Pharmaceuticals was not acquired through merger, since it was formed by New Clicks itself. The second case study deals with the merger between Clicks and the retail portion of Netcare’s Medicross pharmacies and it examines the reasoning of the Competition Commission and Competition Tribunal in detail.
In terms of the second case study and other similar orders handed down by the Tribunal, it has become clear that the analysis before approving or disapproving a merger is based purely on the Competition Act. Neither the Commission nor the Tribunal takes industry-specific law into account when making an order. The effect of a Tribunal order is different to a normal order of court insofar as it serves as a “clearance certificate” of sorts – that there could be no restrictive practices within the merged firm which would render the market less competitive. The order thus does not prevent alternative legal challenges to ownership, licensing or merger questions.
Moreover, the Tribunal can only take decisions based on the current situation. The Tribunal does not project growth when considering the impact on competition. Should an anti-competitive situation arise after the Tribunal has taken a decision, that situation would have to be dealt with in a separate legal process.
The information placed before the Commission and subsequently the Tribunal comes primarily from the merging parties themselves. This leaves a gap in terms of pertinent information which the Tribunal should be mindful of when approving a merger. The Commission does afford objecting third parties a chance to make representations during the investigations. Poor industry regulation is a problem. Were regulators to play a more proactive role alongside the Commission and Tribunal, questions of law which arise from legal instruments other than the Competition Act may play a more prominent role in the Commission’s findings and Tribunal’s decisions.
To illustrate further the difficulties in application of the law, the report contains an account of a meeting between the Independent Community Pharmacy Association and the Minister of Health in October 2016, in which competition issues in relation to Clicks were discussed.
There is a very real need for the change in the manner in which the interactions between the manufacturing and the retail sector are structured. The final brief in the series elaborates upon what these changes could look like.
Chris Pieters, Legal Researcher, HSF
 Report of Supply of Pharmaceuticals in South Africahttps://hsf.org.za/publications/special-publications/pharmaceuticals-in-south-africa/pharma-report-2018.pdf.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africahttps://hsf.org.za/publications/special-publications/pharmaceuticals-in-south-africa/executive-summary-of-report-of-supply-of-pharmaceuticals-in-south-africa.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africa at point 2.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africa at point 7.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africa at point 10.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africa at point 11.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africa at point 13.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africa at point 15.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africa at point 16.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africa at point 18.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africa at point 19.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africa at point 20.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africa at point 21.
 Executive Summary of Report of Supply of Pharmaceuticals in South Africa at point 22.