RTI Project Number

0208665.001

Influenza Vaccine Economics

Issue Brief

October 2005

Prepared for

Amy Nevel, MPH

Senior Public Health Policy Analyst

Office of Science and Data Policy

Assistant Secretary for Planning and Evaluation

Department of Health and Human Services

Mail Stop 445F

200 Independence Ave., SW

Washington DC 20201

Prepared by

Amanda Honeycutt, PhD

Tara Robinson, BA

Christine Layton, PhD, MPH

RTI International\*

Health, Social, and Economics Research

Research Triangle Park, NC 27709

\*RTI International is a trade name of Research Triangle Institute.

Contents

Page

1\. Introduction [2](#introduction)

2\. Background [2](#background)

3\. The Influenza Vaccine Industry [2](#the-influenza-vaccine-industry)

3.1 Barriers to Entry [2](#barriers-to-entry)

3.2 Vaccine Profits [2](#vaccine-profits)

3.3 Demand for Influenza Vaccine [2](#demand-for-influenza-vaccine)

4\. Vaccine Supplier Decisions [2](#vaccine-supplier-decisions)

4.1 Profit-Maximizing Decision Making
[2](#profit-maximizing-decision-making)

4.2 Uncertain Demand [2](#uncertain-demand)

5\. Summary and Conclusions [2](#summary-and-conclusions)

References [2](#references)

List of Figures

Number Page

1 Market Output with Uncertain Demand [2](#__RefHeading___Toc118354511)

2 Price Elasticity of Demand for the Influenza Vaccine
[2](#__RefHeading___Toc118354512)

3 Market Output with Uncertain Demand and a Supply Shortage
[2](#__RefHeading___Toc118354513)

> List of Tables

Number Page

1 Key Strategies to Stabilize Influenza Vaccine Supply
[2](#__RefHeading___Toc118354414)

This issue brief is one of five produced for the Assistant Secretary for
Planning and Evaluation (ASPE) by RTI International. The contents of
these briefs is based on research involving a review of literature
including peer-reviewed journals, media reports, and other nonreferenced
sources (including those identified using the Worldwide Web search
engine Google) as well as confidential interviews with 30 key informants
representing influenza vaccine manufacturers, wholesalers, community
immunizers, state and local public health officials, and other experts.
The other briefs in the series are

-   *Influenza Vaccine: Who Buys It and Who Sells It*

-   *Influenza Vaccine Demand: The Chicken and the Egg*

-   *Influenza Vaccine Manufacturing*

-   *Influenza Vaccine Overview: Summary and Assessment.*

This issue brief was written by Amanda Honeycutt, PhD, Tara Robinson,
BA, and Christine Layton, PhD, MPH.

# Influenza Vaccine Economics {#influenza-vaccine-economics .head-1-no-TOC}

# Issue Brief {#issue-brief .head-1-no-TOC}

## 1. Introduction

In the fall of 2004, the United States experienced a severe shortage of
influenza vaccine when Chiron, a manufacturer that had pledged to
provide 46 to 48 million doses of the vaccine to the U.S. market, was
forced by U.S. and U.K. regulators to suspend production due to possible
bacterial contamination in its Liverpool, England, plant. The loss of
Chiron's 46 million doses reduced the number of influenza vaccines
available in the United States to approximately half the amount
anticipated. Sanofi Pasteur[^1] had been expected to supply
approximately 54 million doses, and MedImmune intended to provide about
1.1 million doses of its FluMist vaccine, which is licensed for use in
healthy persons 5 to 49 years of age (Centers for Disease Control and
Prevention \[CDC\], 2004). Following the announcement of Chiron's lost
vaccine production, Sanofi Pasteur and MedImmune increased production,
ultimately producing approximately 58 million and 3 million doses,
respectively (U.S. Influenza Supply, 2005).

This issue brief summarizes factors affecting the supply of influenza
vaccine to the U.S. market and possible strategies to reduce or
eliminate future vaccine shortages. In the next section, we provide some
context for our discussion by describing recent changes in the influenza
vaccine industry and in regulatory requirements for vaccine production.
Section 3 contains a description of the influenza vaccine industry and
factors affecting the profitability of vaccine production compared to
production of other biologic products or pharmaceuticals. In Section 4,
we consider factors affecting the decisions of individual suppliers
about the amount of influenza vaccine to produce in a given year. In
Section 5, we discuss possible strategies to prevent future shortages of
influenza vaccine.

Shortages or delays in the supply of influenza vaccine to the United
States have occurred in three of the past four influenza seasons
(Coleman, Sangrujee, Zhou, & Chu, 2005). The shortages mean that many
people who want a "flu shot" at the going price are unable to get one.
Even more disturbing, these shortages suggest that U.S. systems for
manufacturing and distributing influenza vaccine are ill prepared to
stem the spread and impact of a pandemic influenza viral strain.

Academic, government, industry, and media researchers have offered
several possible explanations for the recent shortages and shortfalls of
influenza vaccine. One possible explanation is that excessive regulation
of vaccines and their production processes for the U.S. market drove
several manufacturers out of the vaccine market and creates barriers to
entry for firms new to the industry (Calfee & Gottlieb, 2004). Another
is that the relatively low profitability of producing vaccines compared
to pharmaceuticals discourages new manufacturers from entering the
industry (Kremer & Snyder, 2003). Further, because demand for the
influenza vaccine is uncertain, and any excess supply of vaccine has
essentially no value past January, manufacturers tend to err on the side
of producing too little rather than too much vaccine. Frank Sloan is an
academic economist who has written extensively about vaccine financing
and supply issues. He has likened annual decisions about how much
influenza vaccine to produce to the decision of how many turkeys to
stock in grocery stores the week before Thanksgiving: "Some stores must
throw away turkeys on Friday, but they make enough on turkeys they sell,
and don't want to run out" (Manning, 2004). However, unlike turkeys for
Thanksgiving, influenza vaccine prices may not be sufficiently high to
cover manufacturers' losses when vaccines go unused and must be thrown
out.

## 2. Background

In the 1990s, four companies supplied the United States with influenza
vaccine. However, in 1999 the U.S. Food and Drug Administration (FDA)
adopted new laws regulating the production of vaccines, which ultimately
led to the exit of two suppliers from the influenza vaccine industry
(Grady, 2004).[^2] Parkedale was ordered to cease operations in 2000
after FDA identified compliance problems, and Wyeth left the market in
2002 after being fined more than \$30 million for manufacturing practice
violations (Danzon, Pereira, & Tejwani, 2005). The exit of Parkedale and
Wyeth left only two firms supplying trivalent inactivated influenza
vaccines (TIVs) to the U.S. market: Sanofi Pasteur and Chiron. In 2003,
Chiron expanded production capabilities by purchasing a Powderject
influenza vaccine plant in Liverpool, England, and rapidly increased
influenza vaccine production from 25.6 million doses in 2002 to 35.6
million in 2003 (Danzon et al., 2005). Chiron pledged to supply 46 to 48
million doses to the U.S. market in 2004 (Danzon et al., 2005). Although
MedImmune produces FluMist as a viable alternative to TIV, FluMist is
not a perfect substitute because it is a live, attenuated influenza
vaccine (LAIV) that is currently licensed for use only in healthy
individuals between 5 and 49 years of age. Therefore, this brief focuses
primarily on production shortages of TIVs, which are licensed for use in
all age groups and for people with chronic medical conditions.

The decline in the number of vaccine manufacturers is not unique to the
influenza vaccine market. The number of major U.S. vaccine manufacturers
fell from 17 in 1980 to 5 in 2004 (Offit, 2005). Only four manufacturers
currently produce children's vaccines for the U.S. market, and some of
those vaccines have only one manufacturer (Coleman et al., 2005).

The small number of manufacturers providing influenza and other vaccines
to the U.S. market is a major contributor to shortages or disruptions in
supply. If a vaccine has only one manufacturer, a production problem
"immediately disrupts supply" (Coleman et al., 2005). But even when
there are two or three manufacturers, as in the influenza vaccine
market, the loss or delay of one manufacturer's output generally cannot
be made up quickly by other suppliers. In the next section, we examine
the influenza vaccine industry and attempt to understand the features of
the industry that may be related to recent shortages of influenza
vaccine. Our discussion specifically addresses why there are so few
suppliers of the influenza vaccine to the U.S. market, despite recent
increases in the number of people in groups targeted for the vaccine
(Harper, Fukuda, Uyeki, Cox, & Bridges, 2005), and why influenza vaccine
manufacturers tend to produce such limited quantities of the vaccine.

## 3. The Influenza Vaccine Industry

Although influenza vaccination may be associated with significant
benefits for society, such as reduced influenza-related medical care
costs and increased productivity among working adults, the vaccine is
manufactured by private, for-profit pharmaceutical companies that may
not take the broad societal benefits into account when deciding whether
and how much vaccine to produce. These companies make decisions about
whether to produce for the U.S. influenza vaccine market and how many
doses to produce based primarily on profit considerations---whether they
can sell influenza vaccine for more than it costs to make it. As one
industry informant described, "We are a for-profit, publicly traded
company. What I like to tell people is that neither Santa Claus nor
UNICEF is listed on the NYSE." In this section, we first consider the
relationship between the number of producers in a vaccine market and
vaccine shortages. We then discuss several factors that may affect
manufacturers' decisions about whether to participate in the influenza
vaccine market.

The production of influenza vaccine typically requires 6 to 8 months
from start to finish. Although newer technologies are under development
to produce vaccines using cell-based technologies (the current process
requires growth of influenza virus in chicken eggs), cell-based methods
are expected to minimally reduce production times, to about 5 months
(Rosenwald, 2004). Because of the long time required to produce
influenza vaccines, the loss of one manufacturer's production can rarely
be made up by other manufacturers during the same influenza season.
Moreover, when only two manufacturers provide the full supply of TIV, as
in the U.S. market in 2004--2005, the loss or delay of one producer's
output is likely to create a significant vaccine shortage. The loss of
Chiron's vaccine output in 2004--2005 essentially cut in half the amount
of influenza vaccine available for U.S. consumers. In this section, we
consider several possible explanations for the small number of influenza
vaccine suppliers to the U.S. market: barriers to entering the industry,
low profits for vaccine manufacturers, and low demand for the influenza
vaccine.

### 3.1 Barriers to Entry

The term "barriers to entry" refers to production costs that must be
borne by a new manufacturer upon entry to an industry but are not borne
by incumbents. Common examples of barriers to entry are ownership of
exclusive rights to a resource (e.g., oil) or a license to produce
(e.g., a patent) and large sunk costs, such as large investments in
production facilities. In the case of the influenza vaccine market, FDA
licensing and regulatory requirements for vaccine manufacturers may
serve as significant barriers to entry for potential new producers.

FDA requires evaluation of the safety and efficacy of all new vaccines
through clinical trials in the target population. The cost of conducting
these trials may account for as much as half of the overall costs of
developing and producing a new vaccine. According to one industry
informant, vaccine clinical trials cost several thousand dollars per
enrollee, and approximately 30,000 to 70,000 individuals must be
enrolled to clearly demonstrate safety. In addition to the cost of
conducting a clinical trial for a vaccine, the firm must bear the cost
of building a small-scale production facility to make the vaccine used
in a clinical trial.

FDA will accept clinical trials conducted outside of the United States
only if they meet FDA requirements. Currently, there are 17 World Health
Organization (WHO)--approved global manufacturers of influenza vaccine
(WHO, 2005). They produce a total of 25 influenza vaccine products, 3 of
which are sold in the United States (Fluzone, Fluvirin, and FluMist). If
vaccine clinical trial data from other countries were approved for use
in the United States, it is likely that some of the other 14 global
manufacturers of influenza vaccine would decide to produce vaccine for
the U.S. market. To help protect against future shortages of influenza
vaccine in the United States, FDA has reported a willingness to
"consider approaches to licensing such as accelerated approval based on
likely surrogate markers (e.g., the degree of antibody response to the
vaccine), followed by postlicensure clinical effectiveness evaluation"
(Goodman, 2005).

Another barrier to entering the influenza vaccine market is the
requirement that firms demonstrate the capacity to produce vaccine
before FDA will grant a production license. Production facilities take 5
to 7 years to build (Brown, 2004b), and because they are highly
specialized, cannot easily be converted for use in producing alternative
vaccines or biologic products. Consequently, firms that decide to enter
the influenza vaccine market must bear the risk of losing about \$100
million to \$150 million in production facility investments if FDA
decides not to grant a production license (although FDA has never yet
failed to grant such a license).

A related challenge is that each vaccine production facility must be in
compliance with current Good Manufacturing Practices (cGMPs) (Orenstein,
Douglas, Rodewald, & Hinman, 2005), which demonstrate the safety of the
production process, equipment, and overall plant. To demonstrate
compliance with cGMPs, firms must engage in a process of continuous
evaluation and plant upgrades, which can be expensive, especially for
new entrants to the market. Incumbents may have a cost advantage over
new manufacturers if they have already developed and implemented
strategies for complying with cGMP regulations that allow them to
produce the vaccine at a lower cost per dose.

### 3.2 Vaccine Profits 

Most vaccines are now manufactured by large pharmaceutical companies
that produce drugs and a broad range of biologics, including vaccines.
It has been argued that the relatively low profitability of vaccines,
compared to drug profits, is driving pharmaceutical companies to abandon
vaccine production in favor of drug production. A number of
pharmaceutical companies have pointed to low profits as their reason for
exiting the vaccine industry. Although global vaccine sales in 2001 were
approximately \$5 billion, sales of therapeutic drugs exceeded \$300
billion (Thomas, 2002).

When asked why vaccines are still being manufactured by private,
for-profit companies, some industry informants indicated that
pharmaceutical companies are developing and producing vaccines primarily
to obtain positive recognition and press about these activities rather
than for the profit motive. To provide a clearer picture of why
pharmaceutical companies might rationally choose to abandon vaccine
production in favor of making drugs, Kremer and Snyder (2003) modeled
the decision about whether to produce vaccines or drugs and demonstrated
that drugs are more profitable than vaccines under a number of plausible
assumptions.

However, for the influenza vaccine, it may not be low profits that are
driving firms out of the industry or keeping potential new entrants out.
Firm profits are equal to revenue minus production costs, where revenue
is calculated as the price of the vaccine multiplied by the number of
doses sold. If the profits associated with the production of influenza
vaccine are, in fact, lower than the profits from producing drugs, then
either the production costs for influenza vaccine are much higher than
for drugs, prices are lower, the market for the vaccine is smaller
(i.e., the number of influenza vaccine doses that can be sold is lower
than for drugs), or some combination of all three. In this section, we
focus on whether low anticipated influenza vaccine profits limit the
number of producers for the U.S. market. In Section 4, we address the
impact of profit considerations (i.e., pricing, costs, market size, and
competitors' behavior) on individual firms' decisions about how much
influenza vaccine to produce in a given year.

#### 3.2.1 Influenza Vaccine Prices

Although production costs for influenza vaccine may have increased over
the past few years due to the need to comply with expanded cGMPs, prices
have also been rising. Influenza vaccine prices have risen fourfold
since the late 1990s (Pollack, 2004). Although the federal government
purchases a large fraction of recommended children's vaccines and could
potentially exert significant control over the pricing of those
vaccines, only a small fraction of the total output of influenza vaccine
is purchased directly by the federal government. The notion that federal
government purchases of vaccine effectively establish the "going price"
at the government price per dose is probably not relevant for the
influenza vaccine market. In 2004--2005, the government price for the
influenza vaccine was \$6.80 per dose, whereas the wholesale price for
private purchasers was \$8.50 (Manning, 2004).

#### 3.2.2 Market Size for the Influenza Vaccine

The size of the market for influenza vaccine is difficult to predict
from year to year because demand for the vaccine depends to some extent
on unpredictable features of the influenza season, such as the timing
and severity of outbreaks. Demand uncertainty will be discussed in some
detail in Section 4 and also in the companion brief *Influenza Vaccine
Demand: The Chicken and the Egg*. Despite fluctuations from year to
year, the overall demand for influenza vaccine has grown since the early
1990s. Demand is likely rising because of (1) demographic changes in the
United States, creating growth in the size of the target population;
(2) expansion of the target population for the vaccine (Harper et al.,
2005); and (3) increases in the number of healthy individuals who obtain
the vaccine to protect family members and minimize work loss and
suffering due to influenza illness. Additionally, because the influenza
vaccine is administered annually, the market is much larger than for
vaccines that require only a few doses over the lifetime.

Merrill Lynch, an investment firm, expects continued growth in the
worldwide demand for influenza vaccine and reports that the influenza
vaccine is "one of the few vaccine products that has drug-like sales
growth" (Merrill Lynch, 2003). In the United States, the number of
people in priority target groups for the vaccine in 2004--2005 was 88
million, and the number in additional target groups (e.g., health care
workers) was 95 million. Increased demand for the influenza vaccine may
lead to additional increases in price and, hence, profits for producers.

#### 3.2.3 Production Costs for the Influenza Vaccine

The cost of producing the influenza vaccine consists of the ongoing cost
of all inputs, such as the eggs required to grow the vaccine, the labor
required to produce and manage the quality of the vaccine, and the
energy and other ongoing costs required to keep the production facility
running. As mentioned previously, manufacturers must incur large
upfront---or sunk---costs to produce the influenza vaccine, such as the
costs of clinical trials and FDA licensing and the cost of building or
purchasing and upgrading a vaccine production facility to meet FDA
requirements for vaccine production. Although these sunk costs are
large, they serve primarily as barriers to entry---once firms have made
these investments (incurring costs that cannot be recouped), decisions
about whether revenues from the influenza vaccine are high enough to
cover costs focus primarily on day-to-day production costs.

Any increase in the ongoing costs of production will lead to a decrease
in firm profits. In the case of the influenza vaccine, the costs of
complying with cGMPs increased in the late 1990s, which tended to reduce
vaccine profitability. However, one industry informant reported that the
per-dose cost of complying with cGMPs is relatively low, suggesting that
these costs had a minimal impact on reducing the profits for producing
the influenza vaccine.

#### 3.2.4 Investments in New Technology for Producing Influenza Vaccine

Additional indirect evidence that the influenza vaccine is indeed
profitable is seen in the growing number of firms pursuing new
technologies for producing the vaccine. Data from Finkelstein (2004)
indicate that there were no clinical trials for influenza vaccine
products between 1983 and 1989. From 1990 through 1993, there were 4
clinical trials for new influenza vaccine products, and from 1994
through 1999, there were 15 clinical trials---an average of 2.5 per
year.

### 3.3 Demand for Influenza Vaccine

The demand for the influenza vaccine may be viewed by producers as too
low to make it profitable to enter the market. Most informants
interviewed indicated that about 80 million doses of influenza vaccine
are demanded in a typical year, not considering year-to-year
fluctuations in demand. Even if everyone in targeted groups were to seek
out the influenza vaccine, the number of doses demanded would be
approximately 183.3 million per year, or 62 percent of the estimated
total U.S. population of 297.2 million in 2005 (CDC, 2005b). If demand
for the influenza vaccine were to increase dramatically, additional
firms may choose to enter the market. In fact, expected increases in
demand may be an important factor behind the decisions of
GlaxoSmithKline (GSK) and ID Biomedical to enter the U.S. influenza
vaccine market in 2005 and 2007, respectively. On the other hand, it is
also possible that no new firms would enter the market, and expected
increases in demand would be met by existing firms through expanded
production.

One federal expert expressed the belief that increased demand for the
influenza vaccine was a critical component to encouraging new firms to
enter the influenza vaccine market and limiting future shortages.
Another remarked that even increased U.S. demand for the influenza
vaccine would not necessarily lead to the entry of new firms to the
market. This expert explained that the large vaccine manufacturers have
an incentive to split the business so that each has monopoly control
over one or two vaccines. The expert stated that financial reports
indicate that Merck has come to a legal agreement to give GSK a
percentage of Merck profits on Merck's new human papillomavirus (HPV)
vaccine. Such an agreement essentially "give\[s\] over the HPV vaccine
as a monopoly to Merck" and creates an incentive for GSK to stop the
process of developing an alternative HPV vaccine. Such an outcome may be
particularly likely where the capacity to produce has not yet been
created. Because several companies worldwide have the capacity and the
licensing in place to produce the influenza vaccine for specific
markets, it may be less likely that any one or two manufacturers would
attempt to monopolize the U.S. market. Indeed, we found no evidence of
collusion among firms currently operating in the U.S. influenza vaccine
market.

## 4. Vaccine Supplier Decisions

In the previous section, we discussed factors that may limit the number
of producers of influenza vaccine for the U.S. market, including
barriers to entry, low profits, and low demand for the influenza
vaccine. In this section, we consider the question of how each influenza
vaccine manufacturer decides on the amount of vaccine to make each year
and the factors that influence this decision, such as perceptions about
competitors' output levels and demand.

### 4.1 Profit-Maximizing Decision Making 

In economics, firm behavior is typically modeled as the decision of how
much of a product to make to maximize firm profits. In the case of only
two firms (i.e., a duopoly), such as in the U.S. market for TIVs, each
firm's decision about how much vaccine to produce depends on the level
of production expected from the other firm (Gibbons, 1992).[^3] Although
each firm could maximize profits by acting jointly as a monopoly and
splitting the market to obtain monopoly prices on all the output
produced, economic game theory suggests that each firm, acting
simultaneously and with perfect knowledge of the other's cost structure,
will in fact decide to produce more than one-half the monopoly output,
which serves to drive down the market-clearing price and raise the total
industry output.[^4] Although the total output from both firms is likely
to be lower than what would be expected in a perfectly competitive
market with many firms producing identical vaccine products, it is
nonetheless unlikely that the duopoly market structure is leading to
significant underproduction of the influenza vaccine and driving recent
shortages.

### 4.2 Uncertain Demand 

Although demand for the influenza vaccine has grown significantly over
the past 20 years, demand still fluctuates from year to year, depending
on many factors that are difficult to predict and impossible to control,
such as the timing of influenza outbreaks in a season and the perceived
severity of the disease. If the public perceives that the influenza
strain is mild or if outbreaks of the disease do not occur until January
or later, an excess supply of the vaccine is likely. Further, if the
prior season was mild and if many individuals who went without influenza
vaccine in the prior season remained healthy, demand in the current
season is likely to be relatively low. In contrast, producers of
children's vaccines can typically predict demand based on the size of a
given birth cohort.

An additional challenge for influenza vaccine manufacturers is that
decisions about how much vaccine to produce for the coming influenza
season must be made at least 6 months in advance. At that early stage,
it is especially difficult for manufacturers to predict demand for the
vaccine, although orders placed at that time by providers, pharmacies,
governments, and others help manufacturers determine how much vaccine to
produce for the fall. Such "prebooked" vaccine orders help manufacturers
estimate the expected demand for influenza vaccine. In Figure 1, market
supply of the influenza vaccine is Q^E^\*, an amount that is selected
based in part on the number of doses that are prebooked in the spring.

[]{#__RefHeading___Toc118354511 .anchor}Figure 1. Market Output with
Uncertain Demand

![](media/image1.wmf){width="4.745833333333334in"
height="3.0027777777777778in"}

D^expected^ = expected demand curve ; D^high^ = curve when demand is
high; D^low^ = curve when demand is low; P^E^\* = price; Q^E^\* =
quantity expected; Q^shortage^ = quantity when a shortage occurs;
Q^surplus^ = quantity when a surplus occurs; S = market supply

However, demand for the influenza vaccine often deviates from the
expected demand. Figure 1 depicts the problems that can arise when
producers over- or underestimate demand for the influenza season. In
Figure 1, producers expect that demand for the influenza vaccine will
follow curve D^expected^, and market supply is given by curve S. Market
output is then Q^E^\* doses of the influenza vaccine sold at a price of
P^E^\* (dollars per dose). If demand turns out to be higher than
expected, as shown by curve D^high^, then the public will wish to
purchase Q^shortage^ doses of the vaccine at P^E^\*. However, because
output is essentially fixed at Q^E^\* due to the long production process
for the influenza vaccine, a shortage occurs.

If demand is lower than expected, as represented by curve D^low^, then
the public will be willing to purchase only Q^surplus^ doses of the
vaccine at P^E^\*, leading to a surplus. Although the manufacturers may
have some flexibility to lower their prices and sell additional doses of
the vaccine, they are still likely to end up with extra doses, which
have essentially no value by the middle of the influenza season. Dr.
Peter Paridiso, Vice President for New Business and Scientific Affairs
at Wyeth, reported that Wyeth had to throw out half of the doses it
produced in 2002 (Grady, 2004). Wyeth exited the industry in 2002 after
being fined \$30 million for cGMP violations (Danzon et al., 2005).
MedImmune had to discard 5 million doses in 2003, and Sanofi Pasteur
destroys about 15 percent of the vaccines it makes each year (Brown,
2004a). Even during the 2004--2005 influenza season, in which there was
a shortage, approximately 5 million doses of vaccine went unused. The
possibility of producing too much vaccine and losing money on the doses
that must be thrown out may lead manufacturers to err on the low side
when predicting demand for a season. Consequently, if demand turns out
to be high, vaccine shortages may be large.

#### 4.2.1 Pricing Decisions

Although industry informants were unable to shed much light on the
pricing decisions of influenza vaccine manufacturers, we can infer that
the federal government price charged for the influenza vaccine (about
\$6.80 in 2004--2005) at least covers the cost of producing a single
dose of the vaccine. We can further infer that the wholesale price of
approximately \$8.50 in 2004--2005 was the highest price for which firms
believed they could sell all of the doses produced (Figure 1).
Reimbursement rates offered by Medicare or private insurance companies
could influence the price of the influenza vaccine, but none of the
industry informants indicated that reimbursement affected their firm's
pricing decisions. However, higher reimbursement rates, which cover the
costs of the vaccine and its administration, may provide an incentive
for more health care providers to purchase the vaccine and encourage
their patients to get vaccinated.

Firms' decisions about what price to charge for the influenza vaccine
are based in part on perceptions about the price elasticity of demand
for the vaccine. If demand for the influenza vaccine is relatively price
inelastic---that is, consumption changes very little in response to
changes in price (Figure 2)---then manufacturers could raise the price
of the vaccine and still sell about the same number of doses. One
informant indicated that demand for the influenza vaccine is probably
highly inelastic with respect to changes in price, and recent
experiences in the United States support this assertion. In the case of
inelastic demand, surpluses of the vaccine could not be fully eliminated
by price reductions. However, vaccine shortages could drive prices up
considerably. During the 2000--2001 influenza season, when vaccine
shortfalls arose because of manufacturing delays, one provider reported
paying as much as \$12.80 per dose for influenza vaccine purchased in
November, although the same provider had been able to order vaccine in
spring 2000 for only \$2.87 per dose (Heinrich, 2004). In anticipation
of price gouging in 2004--2005, the Federal Inspector General and
several state inspectors general notified sellers that those
participating in price gouging would be severely prosecuted. If demand
is highly elastic, then even small price increases (decreases) could
lead to large reductions (increases) in the number of doses sold
(Figure 2).

[]{#__RefHeading___Toc118354512 .anchor}Figure 2. Price Elasticity of
Demand for the Influenza Vaccine

![](media/image2.wmf){width="5.330555555555556in"
height="3.6034722222222224in"}

With elastic demand, a small increase in price (P~1~ to P~3~) will cause
a large reduction in quantity demanded (Q~1~ to Q~3~). With inelastic
demand, a large increase in price (P~1~to P~2~) will cause only a small
decrease in quantity demanded (Q~1~ to Q~2~).

#### 4.2.2 Vaccine Distribution

The system for distributing vaccines may offer some protection from the
risk of profit losses associated with surpluses of the influenza
vaccine. Manufacturers typically accept "prebooked" orders for the
influenza vaccine in the spring before the influenza season, which
establishes a baseline level of demand. Producers then sell vaccines
either directly to providers or pharmacies (generally through prebooked
contracts that specify the price and quantity in advance), wholesalers
(companies that provide a broad range of medical supplies to doctors'
offices and other health care providers), or governments (local, state,
and federal).

MedImmune offers buyers the option of returning unsold vaccine if they
pay a higher upfront price per dose. In the 2004--2005 influenza season,
MedImmune sold its nasal vaccine, FluMist, for \$24.50 per dose with the
option of returning unsold doses, and for \$19 to \$20 per dose for
doses that could not be returned if not used. Such a practice means that
the manufacturer bears virtually all of the risk of profit loss in a
low-demand season, which is probably why the practice was abandoned by
other influenza vaccine producers following the 2000--2001 influenza
season.

## 5. Summary and Conclusions

In this brief, we have considered several possible explanations for
recent shortages or shortfalls of influenza vaccine to the U.S. market.
We first addressed the question of why there are so few producers of the
vaccine for the United States. The small number of producers and the
lengthy production process mean that manufacturing problems for any one
producer are likely to cause a shortage. Possible reasons for the small
number of producers of influenza vaccine for the U.S. market are
barriers to entry, low profits, and low demand for the vaccine. We found
evidence that FDA requirements for licensing and production, especially
the requirements that clinical trials be conducted on U.S. subjects and
that production facilities be up and running before licensure, likely
limit competition in the influenza vaccine industry by preventing new
firms from entering. We also considered whether low profits and low
demand for the influenza vaccine help to explain the small number of
producers. There is evidence that the influenza vaccine is profitable,
because annual vaccination is needed and because the size of the market
is growing. However, it is unclear whether profits are high enough to
induce pharmaceutical companies to invest in producing the influenza
vaccine rather than investing in the development of drugs. We also found
evidence that efforts to increase the demand for influenza vaccine might
lead to the entry of new firms to the market. On the other hand, it is
also possible that increases in demand would be met by expanded
production on the part of existing manufacturers.

The second question we considered was how each firm in the influenza
vaccine industry makes output and pricing decisions and the extent to
which the decisions of individual firms may lead to too little output
and ensuing shortages of vaccine. In markets with only a few producers,
such as the influenza vaccine market, economic theory suggests that
output will likely exceed the monopoly output level but will nonetheless
be lower than in a perfectly competitive market, where no single firm
exercises control over prices. Consequently, market structure does not
appear to limit influenza vaccine output significantly. Uncertain demand
for the influenza vaccine does tend to limit vaccine production. Because
influenza vaccine makers are unable to sell excess output, they have an
incentive to limit supply, which may lead to a small shortage in years
where the demand for vaccines is greater than anticipated and a much
larger shortage in years where one or more firms experience production
problems (Figure 3).

In this final section, we briefly describe possible strategies to reduce
or eliminate influenza vaccine shortages. We focus on policies that
address the factors, such as barriers to entry and demand uncertainty,
that appear to be key reasons for recent shortages or shortfalls in
influenza vaccine supply. Although CDC has published recommendations
about priority

[]{#__RefHeading___Toc118354513 .anchor}Figure 3. Market Output with
Uncertain Demand and a Supply Shortage

![](media/image3.wmf){width="4.778472222222222in" height="3.50625in"}

D^expected^ = expected demand curve ; D^high^ = curve when demand is
high; D^low^ = curve when demand is low; P^E^\* = price; Q^E^\* =
quantity expected; Q^shortage^ = quantity when a shortage occurs;
Q^surplus^ = quantity when a surplus occurs; S = market supply

Increased demand will cause a shortage under expected supply conditions.
If supply is disrupted, consumers will face an even greater shortage.

groups to receive the influenza vaccine in the event of a vaccine delay
or shortage (Harper et al., 2005), strategies to prevent, and not just
cope with, future vaccine shortfalls are needed.

Some strategies to increase the output of influenza vaccine and prevent
future shortages, particularly in the event of a pandemic, are to

-   harmonize licensing requirements for influenza vaccine producers
    across international markets;

-   increase demand for the vaccine;

-   develop government buy-back or guaranteed purchase programs;

-   create strategic reserves;[^5] and

-   encourage and speed the development and implementation of new
    technologies for producing influenza vaccine.

Table 1 summarizes the advantages and disadvantages of each approach.

[]{#__RefHeading___Toc118354414 .anchor}Table 1. Key Strategies to
Stabilize Influenza Vaccine Supply

+-----------+--------------+-------------+----------------+-----------+
| **S       | **D          | **A         | **D            | **Re      |
| trategy** | escription** | dvantages** | isadvantages** | sponsible |
|           |              |             |                | Entity**  |
+-----------+--------------+-------------+----------------+-----------+
| Harmonize | Harmonizing  | Provides    | Safety         | Federal   |
| inte      | licensing    | easier      | concerns       | g         |
| rnational | requirements | entry to    |                | overnment |
| standards | across       | U.S. market |                |           |
|           | i            | for current |                |           |
|           | nternational | influenza   |                |           |
|           | markets      | vaccine     |                |           |
|           | would allow  | producers   |                |           |
|           | entry of     |             |                |           |
|           | licensed     |             |                |           |
|           | producers    |             |                |           |
|           | from         |             |                |           |
|           | non-U.S.     |             |                |           |
|           | markets      |             |                |           |
+-----------+--------------+-------------+----------------+-----------+
| Shorten   | Streamline   | Encourages  | Safety         | Federal   |
| FDA       | FDA          | entry of    | concerns       | g         |
| approval  | processes to | new firms   |                | overnment |
| process   | reduce the   |             | Licensing and  |           |
| for new   | approval     |             | approval       |           |
| vaccines  | time for a   |             | process would  |           |
|           | new vaccine  |             | still take     |           |
|           | application  |             | many years     |           |
+-----------+--------------+-------------+----------------+-----------+
| Implement | Government   | Limits      | Government     | Federal   |
| purchase  | purchases a  | producer    | costs due to   | g         |
| or        | set amount   | losses due  | sharing in     | overnment |
| buy-back  | of vaccine   | to          | financial risk |           |
| g         | or purchases | uncertain   | of oversupply  |           |
| uarantees | a portion of | demand      |                |           |
|           | excess       |             |                |           |
|           | supply       | Allows for  |                |           |
|           |              | use of      |                |           |
|           |              | unsold      |                |           |
|           |              | vaccines,   |                |           |
|           |              | which       |                |           |
|           |              | cannot be   |                |           |
|           |              | distributed |                |           |
|           |              | to the      |                |           |
|           |              | public in   |                |           |
|           |              | future      |                |           |
|           |              | years, in   |                |           |
|           |              | research    |                |           |
+-----------+--------------+-------------+----------------+-----------+
| Increase  | Methods to   | Increase in | Increased      | Federal   |
| demand    | stimulate    | market size | demand could   | g         |
|           | demand, such | may         | drive prices   | overnment |
|           | as a         | encourage   | up             |           |
|           | national     | additional  |                | Health    |
|           | adult        | ma          |                | care      |
|           | immunization | nufacturers |                | providers |
|           | program,     | to enter    |                |           |
|           | provider     | the market  |                | State and |
|           | incentives   |             |                | local     |
|           | and          |             |                | go        |
|           | education,   |             |                | vernments |
|           | or requiring |             |                |           |
|           | coverage     |             |                | Health    |
|           | under health |             |                | insurers  |
|           | plans        |             |                |           |
|           |              |             |                | Consumers |
+-----------+--------------+-------------+----------------+-----------+
| Create a  | Purchase a   | Provides    | Costly         | Federal   |
| strategic | portion of   | protection  |                | g         |
| reserve   | the vaccine  | against     | May not be     | overnment |
|           | produced by  | shortages   | possible if    |           |
|           | all          |             | production     | State and |
|           | m            |             | problems arise | local     |
|           | anufacturers |             |                | go        |
|           |              |             | Must be        | vernments |
|           |              |             | replaced       |           |
|           |              |             | annually,      | Health    |
|           |              |             | unlike         | care      |
|           |              |             | stockpiles for | providers |
|           |              |             | other vaccines |           |
+-----------+--------------+-------------+----------------+-----------+
| Encourage | Cell-based   | Is less     | Production     | Manu      |
| c         | vaccines use | susceptible | takes almost   | facturers |
| ell-based | mammalian    | to          | as long as     |           |
| vaccine   | cells rather | con         | egg-based      | Federal   |
| p         | than eggs;   | tamination, | processes      | g         |
| roduction | currently    | which may   |                | overnment |
| tec       | under        | reduce the  |                |           |
| hnologies | clinical     | frequency   |                |           |
|           | trial in the | of          |                |           |
|           | United       | production  |                |           |
|           | States       | problems    |                |           |
+-----------+--------------+-------------+----------------+-----------+
| Encourage | Method of    | Decreases   | Technology     | Manu      |
| reverse   | creating the | production  | under          | facturers |
| genetics  | influenza    | time of     | development    |           |
| tec       | vaccine      | reference   |                | Federal   |
| hnologies | using genome | viruses (to | Consumer       | g         |
|           | cloning      | about 2 to  | acceptance may | overnment |
|           | after the    | 3 weeks),   | be a problem   |           |
|           | proper       | allowing    | because the    |           |
|           | strain is    | for quicker | process        |           |
|           | identified   | response to | involves a     |           |
|           |              | shortages   | genetically    |           |
|           |              | (Fedson,    | modified       |           |
|           |              | 2005)       | organism       |           |
|           |              |             |                |           |
|           |              |             | Legal concerns |           |
|           |              |             | regarding      |           |
|           |              |             | intellectual   |           |
|           |              |             | property       |           |
+-----------+--------------+-------------+----------------+-----------+

One strategy that seems to have a great deal of promise is to harmonize
licensing requirements so that firms that are licensed to produce
influenza vaccine for another country could more easily become licensed
to produce for the United States (Milstein & Candries, 2000). A related
suggestion is to streamline the FDA regulatory process so that it would
take much less than the typical 5 to 7 years for a firm to enter the
influenza vaccine market (Sloan, Berman, Rosenbaum, Chalk, & Giffin,
2004). Such approaches could help reduce the considerable barriers to
entry in the influenza vaccine market and encourage new suppliers to
enter the market, making the overall supply of vaccine less vulnerable
to production problems for any single firm. This strategy could also
shorten the time for making vaccine products based on newer technologies
available to the public.

Another promising strategy that could limit the extent to which
uncertain demand drives shortages of the influenza vaccine is a
government buy-back or guaranteed purchase program. Under a buy-back
program, the federal government would agree to purchase some portion of
each firm's surplus of the vaccine for a reduced price. This approach
would limit the financial risk associated with overproduction for each
firm, but would not provide an incentive for the firm to significantly
overproduce, because the buy-back would cover only a portion of
overproduction at a reduced price. Under the guaranteed purchase
strategy, the federal government would agree in advance to purchase a
set amount of vaccine from each producer, which could then be sold to
the public in the event of a vaccine shortage.

The creation of strategic reserves would also eliminate the risk borne
by influenza vaccine manufacturers because any shortages that arose
could probably be eliminated or reduced by using vaccines from the
reserves. This strategy is similar to the government guaranteed purchase
program, although the parties responsible for creating the vaccine
reserve could include all levels of government, providers, and nonprofit
organizations.

Other possible strategies---although perhaps less effective than those
that specifically reduce barriers to entry and uncertainty in
demand---are to increase demand and encourage new technology. Many
different strategies could be implemented to increase demand, including
incentives for providers to vaccinate (such as the increased
reimbursement levels established by Medicare for the 2005--2006 season),
expanded coverage of vaccines by health insurers, and mass campaigns to
increase public awareness of the burden of influenza and the
effectiveness of the vaccine. Increased demand for the vaccine could
encourage new firms to enter the market, and almost certainly would do
so in conjunction with harmonization of international standards.
However, it is also possible that increased demand would simply lead the
existing manufacturers to increase production levels, leaving the public
vulnerable to shortages due to production problems experienced by any
single manufacturer.

Although encouraging the approval and use of new technologies is an
important long-term strategy for reducing influenza vaccine shortages,
cell-based and reverse genetics processes are years away from approval
in the United States. Immediate actions to encourage the entry of new
influenza vaccine producers and limit the impacts of uncertain demand on
producers are needed to prevent future shortages of influenza vaccine.

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[^1]: In 2004, Sanofi merged with Aventis Pasteur to create the Sanofi
    Aventis Group. The vaccine division of the Sanofi Aventis Group
    changed its name to Sanofi Pasteur.

[^2]: The companion brief *Influenza Vaccine Manufacturing* identifies
    the companies that have produced influenza vaccine over the past
    several years and indicates the names of the vaccine products
    manufactured and sold.

[^3]: Each firm's profits are a function of its own output level and the
    output level of its competitor. Profits for firm i = P(q~i~ + q~j~)
    \* q~i~ -- c~i~, where q~i~ is the output level for firm i, c~i~
    represents firm i's costs, and P(q~i~ + q~j~) is the market price,
    which is higher when total market output is low and lower when total
    market output is high.

[^4]: This simplified discussion ignores the difficulty of predicting
    market size in any given year (i.e., assumes a stationary demand
    curve).

[^5]: We use the term "strategic reserve" rather than "stockpile"
    because under current licensing, influenza vaccine can be used for
    only one season and, thus, cannot be stockpiled.