Do Subsidies Improve Drug Delivery in Southern Africa?

Editor’s Note: Every year, 40 or so students in the MIT Center for Transportation & Logistics' (MIT CTL) Master of Supply Chain Management (SCM) program complete one-year thesis research projects. The students are early-career business professionals from multiple countries with 2 to 10 years of experience in the industry. The research projects are sponsored by and carried out in collaboration with multinational corporations. Joint teams of company people, MIT SCM students, and MIT CTL faculty work on real-world problems chosen by the sponsoring companies. In this monthly, series we summarize a selection of the latest SCM research. The researchers for the project described below, Chelsey Graham and Ricardo Ghersa, analyzed the success of subsidies and inventory management practices in making medicines more accessible to consumers in Zimbabwe for their MIT Supply Chain Management Program master's thesis. The work was carried out for a major pharmaceutical manufacturer, and the project was supervised by MIT CTL Lecturer Dr. Jarrod Goentzel. For more information on the program, visit http://scm.mit.edu/program.

Programs to improve healthcare in developing countries rely, to a large extent, on the efficiency of pharmaceutical delivery systems in these regions. In places such as Southern Africa, price inflation along the value chain makes medicines less accessible.

Even if big pharma companies provide their drugs for free, middlemen mark-up the price, and the medicines remain unaffordable for the consumer. Drug companies can provide subsidies to distributors in an attempt to dampen these effects, but how successful is such a mechanism? Another method is to change inventory management practices to make higher volumes of medicines more freely available, but what is the right approach?

The researchers addressed these issues by evaluating a price reduction scheme in Zimbabwe, and by comparing the cost of insourcing versus outsourcing of the distribution function in the same country, for the pharmaceutical company.

Ground-level research

In 2013 the drug company offered a 10% subsidy across all product ranges to a number of healthcare product distributors in Zimbabwe. The manufacturer asked the distributors to offer a lower price to the final consumer by virtue of this reimbursement to distributors.
To investigate the impact of the scheme, the researchers carried out semi-structured interviewed with distributors and pharmacies regarding sales volumes and pricing levels, and consumer buying patterns.

They analyzed distribution practices by developing a model that calculates inventory holding costs, warehousing and transportation costs, for the delivery of medicines from the manufacturer to Lusaka, Zimbabwe.

An effective strategy?

Did the subsidy work? Overall, it did succeed in better aligning price structures. Average mark-ups before the subsidy's introduction was 243%, which fell to 207% in after introduction.

Pharmacies passed the full price reduction to the final consumer, although the level of reduction was a reflection of the pricing applied by the distributor. The price gap between branded and generic alternatives narrowed for two top-selling product lines. Also, two of the five distributors examined experienced increase sales volumes. However, the margins and mark-ups differed greatly from SKU to SKU, so more work is needed to even out the variations in future subsidy programs.

As regards inventory management practices, the researchers found that the current cost of outsourcing distribution is 67% cheaper than insourcing at the existing sales volumes (and a 99.5% service level). At four times that volume outsourcing becomes more expensive than insourcing 95% of the time.

Large forecast errors and substantial minimum order quantities required by manufacturers are two causes of relatively high inventory holding costs.

For further information on the research contact Dr. Bruce Arntzen, Executive Director, MIT Supply Chain Management Program, at [email protected].

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