What happens when a newsvendor decision goes bad? It depends on what the contract says. That is what Novartis is now finding out (Novartis Seeking Vaccine Payments, Wall Street Journal, May 6). Novartis was one of the major pharmaceutical firms scrambling to produce flu vaccine. When the flu proved relatively mild, many countries canceled orders, leaving some ambiguity over who was owed what.
About half of the 15 governments that ordered H1N1 vaccine from Novartis AG ended up canceling part of their orders, and some are still negotiating with the company over payment, according to Andrin Oswald, head of Novartis’s vaccine business. Dr. Oswald said Novartis will seek clearer cancellation terms in future pandemic contracts. “We would need…more clarity in the contract about what happens in the situation we have right now, if a government feels it has too much vaccine,” he said in a phone interview, “because the debates we have right now are not helpful.”
The French, apparently, offered to pay only 16% of the contract price, terms that the Novartis ultimately accepted. The US meanwhile ordered nearly 230 million doses (not all from Novartis) and has used something like 91 million. The Department of Health and Human Services right now is “in discussions” with suppliers about the excess.
This is partly a problem of Novartis’ own making. They are saddled with unused doses and cancellations because they were late in delivering the goods. There was a point in time in which everyone in America was willing to stand in line for hours for a flu shot. Unfortunately, that time came and went before Novartis and the other vaccine makers could produce the vaccine in volume. Once the hysteria died down, the supply was not needed. Now Novartis would counter that these vaccines are notoriously hard to produce, which is true. But they signed a contract that left them with the risk when they couldn’t deliver (and it is arguably efficient to have them carry the bulk of the risk to avoid moral hazard problems).
There is then the question of how Health and Human Services should deal with the manufacturers. It is hard to see why they shouldn’t just low ball them. I mean why not make the French look generous? It seems clear that Novartis et al is going to ask for countries to pick up some of the risk the next time there is a threat of a pandemic. They are going to do that whether the US is generous or mean. In the near term, mean is cheaper.