Wednesday, August 24, 2011

QUIZ: why do hospitals and HMO's get better drug prices than drugstores?

Economist Alan Sorensen has the answer:

The superior bargaining clout of hospitals and HMOs relative to drugstores is attributable to their use of formularies, which enable them to solicit bids from competing manufacturers for an all-or-nothing contract.  Drugstores, in contrast, typically stock their shelves with all competing brands of a drug, and cannot credibly threaten to withdraw their business from a manufacturer that fails to offer a discount.

Bottom line:  the alternatives to agreement determine the terms of agreement.  In this case, the ability of hospitals and HMO's to "steer" patients to particular drugs means that the alternative to agreement is much worse for the drug manufacturer.  This makes the drug manufacturer more eager to reach agreement, which results in better prices.

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