Advanced Purchase Commitments

In Chapter 4 Aidan Hollis examines three proposals in considerable detail. The first is an Advanced Purchase Commitment by sponsors, who offer an explicit subsidy in advance for innovative products. The subsidy offer includes a fixed-dollar amount per unit as well as a commitment to purchase a specific number of units at that price. The second proposal is that sponsors pay annual rewards based on the therapeutic effectiveness of innovative drugs. The third approach is to offer a patent extension on patented products to pharmaceutical companies if they successfully developed a vaccine for a disease such as HIV/AIDS that is highly prevalent, particularly in some low-income countries. Hollis concludes that the third approach is an extremely inefficient way to reward innovation. By contrast, the second approach could correct the market failure directly by rewarding innovative drugs according to their therapeutic effectiveness, which is measurable by cost-effectiveness analysis, a topic discussed later in greater detail in Chapters 10 and 11. 

In this chapter 1 examine and compare three proposals recently made to stimulate private involvement in developing pharmaceuticals for neglected diseases (1) Kremer and Glennerster (2004) and the Center for Global Development (2005) have described in detail a plan for Advanced Purchase Commitments for vaccines, which would commit a global body to pay a fixed subsidy per vaccine delivered for certain diseases, if the vaccine meets prespecified technical requirements and is priced below some level. This would help to solve both access and incentive problems, but is necessarily... 

The Advanced Purchase Commitments approach proposed by Kremer and Glennerster (2004) and the Center for Global Development (2005) has attracted considerable public attention as well as seed funding from the Gates Foundation in recent years. Advanced purchase commitments could be useful for certain types of pharmaceutical products, principally vaccines, to stimulate research by promising a subsidy of a fixed value per unit for a given number of units. The most attractive candidate product for such a commitment is a malaria vaccine, since the health (and economic) benefits from an effective malaria vaccine could be very large. 

Advanced purchase commitments require a technical committee to identify the desired, feasible technical characteristics of a vaccine. The donor institution or sponsor would offer a minimum price to firms that developed a vaccine meeting the technical characteristics. The minimum price would be higher than the market can currently sustain, and it would be achieved by the donor offering copayments to the manufacturer to make up the difference between the market price and the minimum price. For example, the sponsor might make a payment of 13.50 per dose, while the transaction price of the vaccine for the ultimate buyer might be only 1.50. The manufacturer would thus obtain a total price of 15. 

For example, one of the technical characteristics that might be specihed is the effectiveness of the vaccine in giving protection over a period of, say, two years. Suppose a vaccine is developed such that only 50% of the people vaccinated appear to obtain protection. This can raise two problems. If the partially effective vaccine is determined inadmissible to be paid under the Advanced Purchase Commitment plan, despite bringing immense health benehts to millions of people, the innovator is not adequately compensated. But, if it is deemed admissible (perhaps only for a scaled reward), the Advanced Purchase Commitment funding could be used up in a short time, so that a second, 100% effective vaccine expected to arrive two years later might obtain no Advanced Purchase Commitment subsidy at all. 

The difficulty here is that firms incentives to undertake research on potentially very valuable innovations are distorted firms will have strong incentives to exactly meet the technical requirements, but very weak incentives to exceed them or to develop useful vaccines that do not meet them. The essence of the problem lies in the requirement for the sponsor to specify the characteristics of a product that has not yet been developed flexibility is required, because of uncertainty but flexibility puts a great deal of discretion in the hands of the committee judging whether to pay a subsidy, and if so, how much. Farlow and his coauthors complain that such discretion renders the Advanced Purchase Commitment program committee-driven rather than market-driven. ... 

There are really only three possible routes (1) use the commercial market through the patent system to determine the rewards to the innovator, (2) base rewards to innovators on therapeutic benefits, and (3) do not bother measuring at all. Option (1) is the patent system, but this functions poorly for neglected diseases. Advanced Purchase Commitments use option (2) in a half-hearted way, as I describe below. A system of Transferable Intellectual Property Rights, described below, uses option (3). The key issue is that in the absence of meaningful measurement of health impacts, it is necessary to base rewards only on commercial success, and that is not consistent with a mission to improve the health of the poor. 

The Optional Reward proposal is in many ways very similar to Advanced Purchase Commitments, and yet there are important differences. Like the Advanced Purchase Commitment plan, the Optional Reward proposal is a method for increasing overall incentives as well as increasing access. One key difference is that the Advanced Purchase Commitment plan is suited only to drugs whose technical characteristics can be described in advance ... 

The Advanced Purchase Commitment system sets rewards in an anticipatory fashion, presumably based in part on the expected therapeutic impact. Indeed, Kremer and Glennerster (2004, p. 90) observed that the sponsor s commitment should be large enough to motivate research on vaccines, but that it should not be so expensive that alternative health interventions could save more lives with the same resources. They then examined the price per DALY of the Advanced Purchase Commitment proposal, based on some assumptions about the probability of its being successful in speeding up vaccine development. 

The key difference is that the Advanced Purchase Commitment proposal requires one to estimate the therapeutic impact in advance to figure out how much money to allocate, which has the advantage that once the drug is being sold, no further evaluation of its effectiveness is required. 

Unlike an Advanced Purchase Commitment, the Optional Reward proposal requires the sponsor to spend money every year an Advanced Purchase Commitment requires spending only in years in which an eligible vaccine is developed and being used. The reason for this difference is that the Optional Reward proposal assumes that innovations will arrive with sufficient frequency such that, at any given point in time, many of them will be in use and eligible for a reward. Such an assumption seems plausible since the reward system can include prescription drugs, rather than being restricted only to vaccines. 

Finally the Optional Reward proposal is not, after all, incompatible with Advanced Purchase Commitments both systems could operate simultaneously, presumably with the condition that a single product would not be eligible for inclusion in both. 

This information asymmetry poses a powerful challenge to sponsors. The problem is particularly severe for end-to-end proposals, which, as previously noted, are automatically limited to pull incentives like prizes or Advanced Purchase Commitments. These incentives share the generic weakness that sponsors must decide how large a reward to offer. If sponsors offer a reward that is lower than expected costs, no R D occurs. But if sponsors offer a reward that is higher than expected costs, they will pay too much for any desired level of R D. Sponsors could avoid both dangers if end-to-end systems were compatible with contract R D, which lets sponsors set rewards based on sealed bids and other forms of competition that encourage researchers to reveal their true costs. Commercial pharmaceutical companies routinely use contract R D to contain preclinical and human testing costs. 

In practice, one can imagine many possible trade-offs between flexibility and reward size. The most obvious way to reduce risk premiums is to design contracts that minimize sponsors discretion to adjust rewards ex post. One blue ribbon panel recently adopted this position by recommending that sponsors not be allowed to adjust Advanced Purchase Commitment rewards downward even if R D costs fall in the interim (Advanced Markets Working Group 2005). They presumably believed that the increased discretion was not worth the additional risk premium that companies would demand in compensation. Other possible trade-offs include promising to award a fixed sum to the best drug(s) produced within a preannounced time... 

Letter from Roy Widdus to Commission on Intellectual Property Rights, Innovation and Public Health (Hopefully) clarifying the discussion on advanced purchase commitments, advanced market mechanisms for early stage vaccines, and the IFFlm (May 10, 2005). 

In principle, the Advanced Purchase Commitment proposal can also use this approach, since if the subsidy paid by the sponsors is very large, it will attract more firms to compete to develop an eligible vaccine, thus dissipating the available profits. However, to the extent that vaccines are substitutes for each other, there may be a substantial increase in costs without an accompanying increase in therapeutic impact. 

Farlow, A. 2004. Analysis of the Problems of R D Finance for Vaccines and an Appraisal of Advance Purchase Commitments. Preprint. Oxford University of Oxford. Available at www.economics.ox.ac.uk/members/andrew.farlowWaccineRD. pdf search= farlow%20and%20analysis%20of%20the%20problems. 

Advanced purchase commitments moral and practical problems... 

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