I can’t resist joining this great discussion. Thanks for a characteristically provocative and lucid post, and thanks to Andrew and the others for many great points. I will add four.

First, it seems to me that your argument (and the following discussion) overlooks a bit the very important distinction between vaccines with large rich-world markets (pneumo, HPV, rota) and those will little or none (malaria, cholera). For the first class, one could argue that UNICEF/GAVI can drive a fairly hard bargain without putting at risk incentives for innovation. Of course the price still has to cover the cost of building capacity, but not much or any of R&D costs. This is of course why tiered pricing can work. For vaccines of the second class the situation is of course very different, and prices have to cover R&D costs (unless these are covered in some other way). The objection to this simple dichotomy is obvious: firms may take UNICEF/GAVI behavior regarding prices of existing “global” vaccines as an indicator of how they will behave once a “neglected disease” vaccine is developed. For this reason, mechanisms (like AMCs) that provide some assurance of a respectable price in advance may be necessary for vaccines of this type, although I note that to the extent that the big firms are working on neglected disease vaccines now, they probably aren’t doing so primarily for commercial reasons, with the possible exception of Sanofi and dengue.

Second, to follow up on Andrew’s point, the best way to bring prices down (or to accelerate the decline that almost always occurs eventually) is to increase the capacity of emerging market firms to develop follow-on versions of new vaccines and reduce regulatory and other barriers to their entry. In the longer run, this would also help these firms to become truly innovative. It’s difficult for me to believe that having more than five firms capable of bringing entirely new vaccines to market wouldn’t be a good thing. Of course, once developing country firms develop their own new vaccines, they will also have large R&D costs to cover and their business models will evolve. So your basic points will remain in force – the laws of economics will not have been repealed.

Third, we shouldn’t forget that paying more than marginal cost for vaccines is at best a necessary evil, a “second-best” solution, and we should leave the door open to more creative ways to cover R&D costs while permitting purchase at close to marginal cost. The original AMC idea, with its short-term price subsidy and long-term low price commitment, is one way to do this, but various types of prize schemes might be another.

Finally, another very important factor in determining vaccine cost is often overlooked: vaccine design. If cost is a consideration from the start, it will often be possible to develop vaccines that can be produced at much lower cost while meeting local needs. One of the problems with relying on vaccines developed by the big firms for high-income market is that developing vaccines that can be produced cheaply isn’t an important part of their business model. In some cases it may even be cheaper to pay for the development of a new, cheap vaccine rather than purchase an existing one: this is the rationale behind PATH’s meningitis vaccine project.

I also don’t think you can lightly dismiss the fact that the stated “business model” makes no sense. GAVI could do an even better job if it had a sharp and coherent business model and pursued it consistently across the organisation.

Entering into long term commitments with the pharmaceutical industry seems like a good idea, my only comment would be that it might contribute to raise barriers to market entries for new companies wanting to compete on the market – and thus also in the long run keep prices artificially high. I think the pharmaceutical industry needs to be under constant pressure to reduce prices, find and develop new and more efficient ways of producing pharmaceuticals, including vaccines, for the benefit of the consumer.

I also like GAVI, I have been involved in the GAVI HSS Tracking Study for the past year, and it has been interesting to see how GAVI works on the ground and how its support translates into service provision. GAVI works quite well, it has distinct and very clear objectives and it seems to be able to reach out.

Par

Ultimately, yes. But I understand the causality to be profits for vaccinations -> innovation -> lower prices. You are talking about the effects of lower prices, I am talking about the process that brings those lower prices about.

But I think that you’re now shifting your argument. Your original problem was that lower prices wouldn’t result from increased demand. Now you’re saying that once prices start to fall the incentives for further innovation will also fall. Correct, but there’s a plausible defense for the model they outline.

Anthony – once again, we’ll have to agree to disagree. My point has consistently been that increasing demand will not result in lower prices, and for any mainstream economist there really isn’t a huge amount to argue about here. If you want to believe that (a) that increasing demand will reduce prices and/or (b) that GAVI has become an adherent of the Austrian school of economic theory, then all I can do is wish you the best of luck.

One way that GAVI can (genuinely) reduce costs without damaging the industry is by entering into long term contracts for vaccine purchases. Both the International Finance Facility for Immunization and the Advance Market Commitment are examples of this approach.

I read this to imply that GAVI is not doing these things—but maybe that is just because you are being pedagogic? In fact, it’s already doing exactly that, right?

David: absolutely right. Sorry that wasn’t clear.

http://thefilter.blogs.com/thefilter/2009/11/gavis-business-model.html

Owen replies:

Of course I think it should be their goal to stimulate innovation and create incentives for market entry; and I don’t think increases in demand, on their own, would be a cost effective way to do that. That is why I suggest other steps, especially increasing predictability of demand and reducing the risk of hold up, which I think would be effective. If it were really their intention to create the incentives you describe, they would not go about it they way they say they are.

I’ve not thought about this deeply so I may have this wrong, but consider the following scenario. We start out with a monopoly (not sure whether this is relevant for vaccines). Higher demand increases monopoly profits, which, in turn, increases the attraction for other suppliers to enter the market. Hence, competition increases and we move towards a more competitive market in which the price ends up being lower than the price we started with.

Nicolas – that won’t work. If we can see the end result coming, so can the other suppliers who are considering entering the market.

Yi-An – I agree that pharma will respond to the incentives we create for it. Indeed, they are legally obliged to pursue the long-term interests of their shareholders, so it would be rather surprising if they did not pursue patent extensions at the expense of access for the poor. Those are the incentives we create by driving down the price. If we don’t like how they behave, we should change the incentives, not throw up our hands in horror.

The large funding base of GAVI, and its signalling to industry that it will support the introduction of newer and costlier vaccines means that many emerging manufacturers see a business opportunity and seek to enter the market. In general, since their cost structures are lower, this ends up resulting in a long-term price decrease. As you point out, this is not really a consequence of greater demand, but rather greater assurance that a viable market (for which vaccines will be purchased) exists. As for the point about demand rising as a consequence of falling prices, this is partly true. In reality, for many of the newer vaccines, the full cost of those vaccines is well above the level of what many countries can afford, so whether a pneumo vaccine for example is $2.75 instead of $6.50, it’s still beyond the reach of many countries without support from GAVI. The rise in demand is also the consequence of the provision of information and evidence on burden of disease, effectiveness of the vaccine, GAVI’s financial support, etc.

Long-term contracting is certainly part of the solution as you point out. I think the challenge is to make sure that it does not lock the buyer into purchasing from a single supplier. The AMC is designed in such a way as to avoid this. The single supplier issue can be problematic because (a) there is always the risk of production problems interrupting supply; and (b) the “good” price obtained from that manufacturer can sunset leaving the buyer empty-handed if the deal has left the market without a diversity of suppliers.

Lastly – on the UNICEF point, your comment regarding their fixation on low price is actually out of date. In 2000-01, they went through a strategic change in adopting a policy of vaccine security. This policy explicitly considers the overall health of the industry segment AND price. It means in practice that they will always buy from multiple manufacturers although this raises the weighted average price of the product. Some have criticized this approach, suggesting they buy a greater proportion from the lowest price supplier. However, the experience of measles is a case in point, where suppliers exited the market (as you note in your post) and the supplier base dwindled, leading to a fragile market. Their approach has in fact been an important instance where they have balanced the objectives between the public sector and industry to find a solution space that works for both.

Andrew – thanks for these insights from someone who has had much more experience of these issues than me. I am happy to be corrected on UNICEF’s change of approach. But UNICEF’s approach of promoting competition among vaccine suppliers may not be sensible either. It is not completely obvious that it is economically desirable to have multiple suppliers of vaccines: there are large fixed costs and low variable costs, so very large returns to scale. This means that having two suppliers providing (say) half the market each would be likely to result in much higher unit costs than a single monopoly supplier producing for the whole market. In these circumstances it might be better to accept the scale benefits of monopoly supply, and to try to ensure that markets are contestible rather than ensure competition. The savings to purchasers from long term ex ante purchase commitments with a monopoly supplier, in a contestable market, would be larger by far than any savings from driving down spot prices by increasing competition. There is an additional benefit from having multiple suppliers because it may help to increase security of supply (if the supply risks are supplier-specific rather than disease-specific). The question is whether the (probably substantial) extra cost to purchasers of sustaining competition and multiple suppliers is worth paying to improve the security of supply. I’d like to see the cost benefit appraisal before offering an opinion, but my guess is that this would be a hard case to stack up.

Anthony – If they think the supply curve will shift, then their story is back in business. But how is GAVI going to shift the supply curve by increasing demand? If there are supply side changes available that would bring down prices, what stops firms from shifting the supply curve anyway? If GAVI has an analytical framework that explains all this then I look forward to hearing about it. I regret to say that the simpler explanation is more likely: they have simply got this wrong. If they want to shift the supply curve, they need to do something that affects the supply side.

That being said, you’re absolutely right that a monopsony strategy of consolidating buying power to drive down prices is harassing the goose that lays the golden egg (if not killing it outright). GAVI obviously has a stake in that goose if they want more new vaccines and they are involved in advance market commitments – but looking at their 2007-10 Roadmap and Goals, the emphasis clearly seems to be delivering vaccines that are already developed. There’s no goal on getting a new vaccine – just goals on getting more existing vaccines out to children who need them. Your argument that GAVI needs to be thinking about the longer term is important, but if the critical need is to get basic coverage out as soon as possible, a monopsony strategy may make sense. And I would probably argue money spent on delivery of existing is better than money spent on developing new technologies that won’t be accessible for years and years.

My broader question would also be to what extent GAVI’s actions IS changing the investment decisions of pharmaceuticals. This is beyond my pay grade, but I would buy that there’s room to both squeeze pharmaceutical profits in the short-term while also creating longer-term incentives that make it still be attractive and profitable to develop new vaccines.

Yi-An – With respect, that’s an ingenious attempt to defend them, but it doesn’t work. Increasing demand doesn’t shift the supply curve, it shifts the demand curve (and so moves the equilibrium along the supply curve). To shift the supply curve you’d have to change something about the willingness of suppliers to produce and sell at each given price – for example, by changing the cost structure or risks. That’s why I recommend GAVI focuses on reducing costs and risks to suppliers: that would shift the supply curve.