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As millions of Americans look to foreign sources for less-expensive pharmaceuticals, consumers and manufacturers have become locked in a battle over the legitimacy and legality of the so-called parallel market. Given the historic failure of government to block consumers’ access to cheaper products via such markets, the Bush administration would be wise to reconsider its current position on the side of manufacturers. The diversion of sales of pharmaceuticals and other products from domestic sources to foreign sources — through Internet sales or direct sales — is generally known as the parallel market. Goods sold in a parallel market are not counterfeit or fake. They are genuine and, generally, legal. The parallel market is an outgrowth of the trade in goods across regional and national boundaries. The accounting firm KPMG defined parallel market products in a recent report as branded products somehow diverted from an “authorized” distribution channel or imported into another country without a manufacturer’s consent. Since the products are diverted from their intended channel of trade — often without the knowledge of the manufacturer — parallel goods are also referred to as gray market goods or diverted goods. Parallel markets tend to arise when intellectual property owners sell similar or identical goods in different markets at different prices. In the case of Canada, this price disparity is caused by the weaker Canadian economy and by government medical subsidies. In other markets, the price difference reflects an attempt by the manufacturer to subsidize greater competition in one market by charging higher prices in another. Regardless of the cause, the effect is that a price differential exists between different markets. If the price differential is large enough, it becomes profitable for a small entrepreneur to purchase the product in the market where it is sold cheaper, transport it to the more expensive market and sell it, at a profit — but still below the manufacturer’s price. To illustrate, consider an international fragrance distributor that manufactures perfume, which it sells in the United States for $20 an ounce and in France for $12 an ounce. It charges the higher price in the United States to subsidize the lower price in France, which is a more competitive market for fragrances. The American consumer loses and the French consumer wins. An entrepreneur sees an opportunity in this price differential. She can purchase the product in France at the lower price, ship it to the United States inexpensively, and sell it here for $16 per ounce. She makes a hefty profit and still undercuts the manufacturer’s U.S. price. In this example, the U.S. consumer benefits from a lower price at the local discount retailer. An arbitrage is created, forcing the manufacturer to narrow the difference in prices. This is the classic model of parallel market trade. ANTI-MARKET TACTICS The rising prices in pharmaceuticals and the disparities in the pricing of pharmaceuticals across international boundaries have created a natural boom market in parallel market pharmaceuticals. In Europe, the parallel market in pharmaceuticals already totals more than $12 billion. Some reports have estimated that the parallel market in pharmaceuticals along the U.S.-Canadian border was worth $1.1 billion in 2003, while the market along the U.S.-Mexico border was worth approximately $1.9 billion. The U.S.-Mexico trade was up 70 percent in a single year. Brand owners have responded to this boom in parallel market pharmaceutical sales the way that they have always responded to the parallel sales. They disparage parallel market goods, seek legal remedies, and ask for help from Congress. A common business strategy used to stifle the parallel market involves controlling supplies to the foreign reseller. This strategy takes two forms. In the most common tactic, the product is coded for the specific reseller. If the coded product is found in the diversionary market, that reseller is warned to stop diversionary sales or his supply is cut. Unfortunately for the manufacturers, diverters have become very proficient at removing these tracking codes as a regular business practice. A second, more subtle, strategy involves reducing the supplies in the diverting territory. Pfizer recently did this when it reduced its supplies of pharmaceuticals to Canada in order to curtail the growing Internet pharmaceutical trade into the United States. But when U.S. brand owners fail to succeed through business strategies, they often turn to the courts and Congress. Going back more than 80 years, legal battles have been waged using one or another form of intellectual property to combat the parallel trade. Use of trademarks generally has been unsuccessful except in a few unique circumstances where the goods, usually due to material differences or alteration, are likely to disparage the reputation of the trademark. Use of copyrights has been somewhat more effective in barring goods manufactured and first sold abroad. Design patents, although useful, are less frequently used in product packaging and design and therefore are not a common strategy. The political battle against the parallel market has met with mixed success. Almost every year, a variety of laws are submitted to Congress at the instigation of anti-parallel market forces seeking to bar the importation of parallel market goods. Most often these are rejected. But with pharmaceuticals, they have succeeded. LEARNING FROM HISTORY Parallel market trade in pharmaceuticals, including Internet sales, is illegal, though so far there has been little federal enforcement. Not only do such importations violate U.S. Food and Drug Administration rules, but the new Medicare prescription drug benefit law specifically prohibits re-importation of drugs from Canada. The sponsors of the Medicare bill argued that new subsidies to employers and private health insurance plans would encourage market mechanisms to stabilize and possibly reduce drug prices. However, this proposed system, rather than providing an immediate reduction in drug prices, seeks to provide an incentive for employer and health plans to pass price supports to employees. Many consumers, faced with the soaring cost of essential medications, are not persuaded that the incentives will have the intended effect and are unwilling to wait for future changes that may or may not lower prices. The battle over parallel market pharmaceuticals recently exploded in Congress. The battle came over President Bush’s nomination of Dr. Mark B. McClellan, Bush’s former FDA chief, to head the Centers for Medicare and Medicaid Services. As head of the FDA, McClellan was a vehement opponent of changing federal rules to allow consumers to import pharmaceuticals. Under his management, the FDA threatened legal action against local and state governments seeking to provide their citizens with cheaper drugs from Canada. Mindful of powerful public concern over rising prescription prices, Senate Democrats, and even some Republicans, have challenged McClellan’s nomination. Sen. Byron Dorgan, D-N.D., characterized the appointment as “putting the fox in charge of the chicken house.” McClellan was confirmed by the Senate last month only after Senate Majority Leader Bill Frist, R-Tenn., agreed to pursue legislation allowing U.S. consumers to purchase lower-cost drugs from countries such as Canada. At the very least, McClellan’s nomination created a strong public impression of a Bush administration tilt toward big business rather than consumers. The administration, however, would do well to learn from the history of the parallel market. It is a strong and persistent force in our economy. It is a manifestation of market forces to arbitrage disparate pricing and satisfy consumers’ powerful quest for lower prices. Unlike other commodities, pharmaceuticals strike at the deepest concerns of consumers — their health. Passing laws to discourage and even criminalize parallel trade in pharmaceuticals before addressing the critical problem of spiraling drug costs is only likely to trigger public anger. Until the public’s need for affordable drugs is addressed adequately, the parallel market will continue to thrive. Like the effort to ban booze in the early 20th century, the market will find ways to evade this new form of prohibition. Jorge Espinosa is a partner in the intellectual property protection and commercialization practice group at Kluger Peretz Kaplan & Berlin (www.kpkb.com) in Miami. His practice focuses on domestic and international intellectual property matters, including border issues, protection of foreign intellectual property rights in the United States and the consolidation and management of intellectual property services for U.S. companies abroad.

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