How Countries Set Prices for Generic Drugs Using International Reference Pricing

When a country sets drug prices by looking at what others pay, it's called international reference pricing. For generic medicines, this system is used by most high-income nations-but how exactly does it work? The answer isn't simple. Countries have different ways of applying this method, and the results can vary widely from cost savings to drug shortages. Let's break it down.

What is International Reference Pricing?

International Reference Pricing (IRP) is a price control mechanism where governments consider the prices of medicines in other countries to establish or influence domestic prices, particularly for generic drugs. This practice started in the 1980s when Italy, Spain, and Portugal began using it to control pharmaceutical costs. Today, 34 out of 38 high-income countries use IRP in some form, according to the OECD 2020 report. For generic medicines specifically, 28 of 32 European countries rely on IRP as part of their pricing strategy.

How Countries Apply IRP to Generics

Not all countries use IRP the same way. The main difference is between internal reference pricing and external reference pricing. Internal reference pricing compares prices within the same country for therapeutically equivalent drugs, setting a reference price for a group of generics. External reference pricing looks at prices in other countries to set domestic prices.

Germany uses internal reference pricing through its AMNOG system. When a generic drug enters the market, it's grouped with other similar medicines. The reimbursement price is set at the lowest price in the group plus a 3% margin. This keeps costs low while ensuring access. The Netherlands takes a mixed approach: they combine tendering, mandatory discounts, and internal reference pricing. This has led to generic prices being 65-85% lower than originator drugs. Switzerland calculates reference prices as two-thirds of the average international price and one-third based on Swiss comparator drugs.

Most European countries use a reference basket of 5-7 countries. For Western Europe, this typically includes France, Germany, Italy, Spain, and the UK. Eastern European countries often reference Austria, Germany, and the Netherlands. The OECD recommends using average or median prices rather than the lowest price in the basket to avoid unfair volatility.

German pharmacist managing generic drugs with reference coin symbols

Key Differences from Patented Drug Pricing

IRP works differently for generics compared to patented drugs. While 15 of 19 high-income countries use IRP for patented drugs, only 9 use it as the primary method for generics. Most countries combine IRP with other mechanisms like tendering or mandatory discounts for generics. In the EU, 24 of 27 countries use internal reference pricing for off-patent medicines, versus only 12 using external reference pricing. This is because generics are often interchangeable, so internal reference pricing within therapeutic classes makes more sense.

Real-World Challenges of IRP for Generics

Despite its benefits, IRP for generics has real-world problems. Greece intensified IRP during its financial crisis (2010-2018), leading to shortages of 37% of generic medicines by 2015. Portugal discontinued 22 generic products in 2019 due to unsustainable pricing under IRP. A 2019 study showed countries using IRP alone for generics had 22% greater price reductions but 18% longer delays in bringing new generics to market.

Pharmacists in Spain report that while internal reference pricing increased substitution rates to 89%, 63% noted occasional shortages of the lowest-priced reference product. In Greece, 41% of patients had trouble getting specific generic brands due to pharmacy substitutions driven by reference pricing. These issues highlight the need for careful basket design and pricing calculations to balance cost savings with supply stability.

Empty pharmacy shelf with worried patient and pharmacist

Recent Innovations in IRP Systems

France introduced a "dynamic reference pricing" system in January 2023, adjusting generic prices quarterly based on market share shifts. Early data shows 8.2% additional savings compared to static systems. The European Commission launched a "European Reference Pricing Platform" in April 2023, initially covering 15 off-patent medicines across 7 countries, with plans to expand to 100 by 2025.

Industry analysts predict that by 2027, 65% of European generic prices will be determined through reference pricing-up from 58% in 2022. However, the OECD warns that current systems may need adjustments for complex generics, where development costs approach those of innovative drugs. The OECD recommends "more flexible IRP systems for generics that consider manufacturing complexity, with tiered reference groups based on therapeutic importance."

What the Future Holds for Generic Drug Pricing

The global generic market is worth $438.6 billion, with Europe accounting for $140.3 billion. IRP influences 78% of the European generic market. As countries refine their systems, the focus is shifting from pure price control to balancing affordability with innovation. The European Commission's 2023 Pharmaceutical Strategy emphasizes "ensuring appropriate incentives for quality, sustainability and innovation in the generics sector."

Pharmaceutical companies like Teva and Sandoz have mixed experiences. Teva reported a 9% revenue decline in Europe due to reference pricing, despite 15% volume growth. Sandoz, however, expanded market share in 18 European countries through well-designed reference pricing. This shows that the success of IRP depends heavily on how it's implemented.

What's the difference between internal and external reference pricing?

Internal reference pricing compares prices of similar drugs within the same country, setting a reference price for therapeutic groups. External reference pricing looks at prices in other countries to set domestic prices. Most European countries use internal reference pricing for generics because it's more stable and accounts for local market conditions. External reference is more common for patented drugs.

Do all countries use international reference pricing for generics?

No. While 34 of 38 high-income countries use IRP for some medicines, only 28 of 32 European countries apply it specifically to generics. The United States doesn't use IRP for federal programs, though some states like Colorado have limited reference pricing for Medicaid generics. Canada regulates generics through provincial tendering systems instead of IRP.

Why do some countries experience drug shortages under IRP?

Shortages often happen when reference prices are set too low, making it unprofitable for manufacturers to produce the drug. Greece had 37% of generics in shortage during 2012-2015 due to aggressive IRP during its financial crisis. Portugal discontinued 22 generic products in 2019 after price cuts made production unsustainable. Careful basket design and including manufacturing costs in calculations can prevent this.

How do countries avoid price spirals in IRP systems?

A price spiral happens when one country lowers prices, others follow, causing a downward cycle. To avoid this, countries use average or median prices from reference baskets instead of the lowest price. They also limit the number of reference countries (usually 5-7) and update prices less frequently. France's dynamic system adjusts prices based on market share shifts rather than fixed references, which helps stabilize the market.

What role does therapeutic equivalence play in IRP?

Therapeutic equivalence is crucial for internal reference pricing. Countries group drugs that are medically interchangeable, then set a reference price for the entire group. Germany's Federal Joint Committee defines 1,247 reference groups for generics, each averaging 8.3 products. If drugs aren't truly equivalent, the system can break down, leading to confusion or substitution issues. This is especially challenging for complex generics where bioequivalence isn't straightforward.