You may have heard the term “Most Favored Nation Pricing” being used with reference to the pharmaceutical industry. If you have been involved in product distribution or even the financial services industry you may be familiar with that term and how it is used to obtain advantageous pricing. If you are not familiar with that term read further to understand its historical usage and how it may be used by the Trump Administration to help lower drug costs.
How Most Favored Nation Pricing is Used by Distributors
Many large manufacturers use the business model of selling to distributors. Rather than employing a large sales force, they find it easier to establish territories and then assign territories to these distributors that usually have a large and robust sales force with established lines of distribution in various industry verticals such as cosmetics, health, food, beverage, candies, home goods, and electronics.
Now there may actually be several levels of distributors the highest being a “master distributor”. That level is usually achieved by the distributor meeting set minimum sales levels for several months in a row. If the distributor does achieve those sales levels, the master distributor gets the lowest pricing from the manufacturer as well as other possible benefits.
If a new distributor comes along and tries to establish itself in a territory where the product has never been sold before, it might ask the manufacturer for “most favored nation pricing”. That means, in order for that distributor to take on the challenge of this new territory, spend money on advertising, marketing, and motivating its sales force, it may ask the manufacturer for the lowest price it sells to any of its distributors, including the master distributor. That lowest price, is the “most favored nation pricing”.
Now there may actually be several levels of distributors the highest being a “master distributor”. That level is usually achieved by the distributor meeting set minimum sales levels for several months in a row. If the distributor does achieve those sales levels, the master distributor gets the lowest pricing from the manufacturer as well as other possible benefits.
If a new distributor comes along and tries to establish itself in a territory where the product has never been sold before, it might ask the manufacturer for “most favored nation pricing”. That means, in order for that distributor to take on the challenge of this new territory, spend money on advertising, marketing, and motivating its sales force, it may ask the manufacturer for the lowest price it sells to any of its distributors, including the master distributor. That lowest price, is the “most favored nation pricing”.
History of Most Favored Nation Pricing Clauses
The term comes from the import-export industry in which nations or countries would request concessions on pricing and other terms, so they were on a level playing field with other nations or countries. The term means the country which is the recipient of this treatment must nominally receive equal trade advantages as the "most favored nation" by the country granting such treatment (trade advantages include low tariffs or high import quotas). In effect, a country that has been accorded such status may not be treated less advantageously than any other country with that status by the promising country.
The members of the World Trade Organization (WTO) agree to accord MFN status to each other. Exceptions allow for preferential treatment of developing countries, regional free trade areas and customs unions.
It seems only fair of course to help developing countries by giving them pricing and terms similar to that of larger countries. These benefits are passed on to these third world countries for humanitarian reasons and to help them grow. Sometimes you just have to take care of the little guys.
The members of the World Trade Organization (WTO) agree to accord MFN status to each other. Exceptions allow for preferential treatment of developing countries, regional free trade areas and customs unions.
It seems only fair of course to help developing countries by giving them pricing and terms similar to that of larger countries. These benefits are passed on to these third world countries for humanitarian reasons and to help them grow. Sometimes you just have to take care of the little guys.
Most Favored Nation Pricing Used in the Financial Field
When companies need to raise money, one method they use is they sell shares of stock. Whether the company is public or private there is a formula they use. Investment bankers, hedge funds, attorneys, and broker-dealers carefully negotiate the terms. Often the first round of funding is on terms much more favorable to the first round investors because they are taking the most risk, especially if the company is not yet profitable or is a start-up. Those first round investors would be smart to ask for a most favored nation pricing clause. The reason is because if the company does poorly and must raise more money just to stay in business without filing for bankruptcy, then it may have to sell shares at even a lower price than it sold to the first round investors. If it does, the clause would protect the first round investors by allowing them to receive additional shares based on that lower price, without even having to pay more money for those shares.
The clause does not just apply to pricing though, it applies to various terms and conditions. If second round investors got registration rights or warrants or preferred stock rights, then those first round investors would also get those additional benefits pro rata to the amount they invested in the first round. So, the investors protect their rights and their investment to make sure they are treated fairly and this can also help protect against them getting unfairly diluted.
The clause does not just apply to pricing though, it applies to various terms and conditions. If second round investors got registration rights or warrants or preferred stock rights, then those first round investors would also get those additional benefits pro rata to the amount they invested in the first round. So, the investors protect their rights and their investment to make sure they are treated fairly and this can also help protect against them getting unfairly diluted.
Trump’s Use of the Most Favored Nation Pricing Model for Drug Companies
President Trump is using this clause in a prescription drug executive order to reduce costs for seniors. He is goal is to confront the drug companies that charge foreign countries and distributors far less than they charge people in the United States that buy those drugs either directly or through the Medicare Program. Why should United States Citizens pay more for those drugs? To business people familiar with the most favored nation pricing model, it makes perfect sense. One wonders why this wasn’t tried years ago with the drug companies. The answer becomes very political and is likely tied to lobbyists, special interest groups and political contributions.
“It is the policy of the United States that the Medicare Program should not pay more for costly Part B prescription drugs or biological products than the most favored nation price,” Trump declares in a draft version of the executive order. That price, Trump says, “shall mean the lowest price, after adjusting for volume and differences in national gross domestic product, for a [drug] in a member country, with a comparable per-capita gross domestic product, of the Organization for Economic Cooperation and development.”
This is a great quote from the Forbes article by Avik Roy: “In the bizarro world of Medicare drug spending, taxpayers are forced to pay the highest price even though they represent, on the whole, the largest market in the world for prescription medicines. Most importantly, the most-favored-nation approach will do the most to reduce seniors’ out-of-pocket costs, and the most to reduce entitlement spending and thereby the deficit.” Source: Forbes
So, as you can see, most favored nation pricing is a valuable tool that can be used in many different types of business surroundings and is always a matter of negotiation based on the relationship of the parties and what each one brings to the bargaining table. Source: Forbes Article
“It is the policy of the United States that the Medicare Program should not pay more for costly Part B prescription drugs or biological products than the most favored nation price,” Trump declares in a draft version of the executive order. That price, Trump says, “shall mean the lowest price, after adjusting for volume and differences in national gross domestic product, for a [drug] in a member country, with a comparable per-capita gross domestic product, of the Organization for Economic Cooperation and development.”
This is a great quote from the Forbes article by Avik Roy: “In the bizarro world of Medicare drug spending, taxpayers are forced to pay the highest price even though they represent, on the whole, the largest market in the world for prescription medicines. Most importantly, the most-favored-nation approach will do the most to reduce seniors’ out-of-pocket costs, and the most to reduce entitlement spending and thereby the deficit.” Source: Forbes
So, as you can see, most favored nation pricing is a valuable tool that can be used in many different types of business surroundings and is always a matter of negotiation based on the relationship of the parties and what each one brings to the bargaining table. Source: Forbes Article
Conclusion
So, as you can see, most favored nation pricing for small business is a valuable tool that can be used in many different types of business surroundings and is always a matter of negotiation based on the relationship of the parties and what each one brings to the bargaining table. Unfortunately, it may be that larger businesses will have more leverage and buying power to negotiate this type of preferred pricing compared to their small competitors. It is important to make sure you have fully reviewed a contract with a manufacturer, supplier or distributor so that your understand the pricing structure you are agreeing to and if you are getting the lowest pricing possible.
