Tendering Insights From Game Theory

The increase in tendering as well as the entry of multiple biosimilars is disrupting the healthcare market in Europe, with plenty of new players and procedures. This blog looks at how the perspective of game theory could support understanding of these market dynamics.

Game theory principle assumes all players are trying to maximize their gain, whatever the gain is, and that they “play” the move that will ultimately maximize their gain. While extensive research has been done in the field, this blog sticks to the basic game theory principles, leveraging the so-called “prisoner dilemma”, along with a little additional analysis.

In the prisoner dilemma, two players have to make a binary decision. Either they can keep silent and they will be convicted as “guilty”, or they can try to sell the other prisoner. In that case, they would be free while the other would be convicted guilty with maximum penalties.

Typically, in this case, both prisoners would sell the other, with ultimately both getting charged, leading to a sub-optimal outcome. They would choose to “sell” because, in each case, this is the decision maximizing the outcome over the “silent” decision. Sell is therefore a dominant strategy. The system optimum would be for both to keep silent.

How does this simple game translate into the realm of tendering and how can we shed light into a tendering situation? It’s actually fairly simple. In fact, a tender could be viewed as a binary decision, with silent being a small discount or no discount while sell would be a heavy discount. This would lead to the following profit matrix, if we assume the market value is 100 with “low” discounts and that the high discounts value of the market is 60:

In that case, we see that the two players will go for “high” discounts, destroying the market value. This concept is not new, and has been analyzed at length. What is interesting is that, in a number of tenders, and particularly in the biosimilars space, the discount is so low that the matrix could look more like the below:

In this case, there are “two equilibrium”. Remember an equilibrium is a set of decisions within a game that can be predicted by the theory if all players respect the assumptions (maximize their gain and act rationally). “Two equilibrium” means there is no definitive outcome for this game. Additional insights are required to solve the game. The fact that tenders in life sciences are cyclical allows looking at this problem as a repeated game. This can help understanding the behavior of the players.

Due to the repetition, a technique called “backward reasoning” can be leveraged. In short, this technique uses the outcome of the last potential game and chooses the best outcome for the players. In this case, it would be a low discount. It then repeats the same for the round before. This would lead to a low discount in all rounds. Reality likely falls in the middle. The companies will start with high discounts and understand as they repeat the game that low discounts are better. Using these lenses may support the comprehension of the current biosimilars market, where new entrants tend to discount heavily while existing players remain in the game with smaller discounts. As time passes, the game repeats, and the market may see smaller discounts.

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For more perspectives on tendering in the current healthcare market, contact Ruven Remo Eul.