Demystifying FAP, R-zone and the Bi-annual Reimbursement Rate Reductions
February 2012
In April, MHLW will implement the next round of bi-annual reimbursement rate reductions. The
reimbursement cuts are always a source of frustration for foreign companies. For many, the
process seems to lack transparency and predictability.
To better understand the reductions, it is important to understand the key mechanisms that
impact the magnitude of the cuts and the number of products affected. By understanding the
mechanisms, companies can 1) better predict reimbursement price changes and 2) better manage
pricing to help limit their exposure to reductions.
Price reductions are made based on two key mechanisms: the reasonable zone (R-Zone) and
foreign average pricing (FAP). All products risk potential R-Zone reductions; however, only a
limited number of products are subjected to and face the risk of FAP reductions.
What are R-zone reductions?
R-zone reductions are based upon the margins that distributors offer to hospitals for products in a
specific functional category. The MHLW conducts a distributor pricing survey to assess the prices
being charged to hospitals and the resulting margin as a percentage of the prevailing
reimbursement rate. If survey results indicate that discounts exceed the allowable margin
(currently 4%), reimbursement rates will be reduced to bring them back in line with the allowable
margin.
The intention of the R-zone is to prevent drugs and devices from becoming a profit center for
hospitals. Historically, unchecked margins resulted in over prescription and usage. As a result, the
R-zone was introduced as a way to enable hospitals to cover the administrative costs of drugs and
devices without allowing them to make excessive profits.
The best way to avoid R-zone reductions is to avoid price-based discounting. Companies that
compete based on price should expect reimbursement rates for their products to spiral downward
over time.
What are FAP reductions?
Foreign average price reductions are price reductions implemented when a product's
reimbursement rate exceeds 1.5x the simple average of the list price in four reference countries –
US, UK, France and Germany. List price data is obtained directly from manufacturers through an
industry association, the AMDD. Not all products are included in the pricing survey. The product
categories included in each survey are announced in advance and the number of products
surveyed is always a source of contention and negotiation between the MHLW and industry.
Many companies falsely believe that their products are subjected to both R-zone and FAP cuts. In
fact, FAP cuts are calculated after R-zone adjustments have been taken into consideration. As a
result, the cuts are independent and not additive.
The best way to avoid FAP reductions are to 1) not be included on the list of products included in
the list price survey and 2) to develop a global pricing strategy that limits a product's exposure.
A number of techniques can be used to help limit a company's exposure to reimbursement rate
declines.
1. Avoid price-based competition
Price-based competition is the primary driver of R-zone reductions. As an alternative to reducing
prices, companies should consider alternative means of competition such as service improvements
or product enhancements. If companies are unsuccessful in doing so and can only compete based
on price, they should expect to face ongoing downward price pressure. The level of reductions
should be somewhat predictable as it will be reflective of the overall level of discounting that
occurs in the market.
2. Pursue C1 / C2 reimbursement
Reimbursement categories often contain a variety of products with differing features and / or
quality levels. As a result, premium products are sometimes unfairly lumped into reimbursement
categories with more commoditized products that are more likely to be discounted. Because of
the broad nature of some reimbursement categories, even those manufacturers who don't
discount may be subjected to reimbursement rate reductions caused by aggressive discounting by
other participants in their category.
To protect themselves from price erosion within a category, innovative manufacturers should
consider pursuing their own C1 or C2 reimbursement category. By creating an independent
category, the innovator reduces the number and variety of products in the reimbursement
category for their product. In turn, this reduces the likelihood of price-based competition and
reimbursement rate reductions.
3. Develop global pricing policies and strategies
As a result of FAP, companies must think about their product portfolios and pricing at a global
level. To avoid FAP exposure, companies may wish to modify pricing levels in the reference
countries and / or offer a different product mix in each country.
FAP has received a significant amount of press and is often the subject of industry frustration;
however, in recent years, R-zone has become a much more significant threat to reimbursement in
Japan. The calculation methods used for both mechanisms are fairly clear and transparent. With a
little planning, companies can better predict and protect themselves from reductions. Because
both mechanisms are dependent in part on the manufacturer's own pricing, the magnitude of
reductions should be relatively predictable assuming the mechanisms for reduction are well
understood and the manufacturer has an understanding of the pricing dynamics in their product
categories.