Reconsidering Volume‐Based Drug Procurement Policy: The Consequences of Manufacturers' Optimal Production Planning and Breach Strategies

ABSTRACT This paper examines the impacts of Volume‐Based Procurement (VBP) policies on pharmaceutical supply chains, with a focus on the strategic behaviors of manufacturers. VBP aims to reduce costs and stabilize supplies by centralizing procurement through competition based on volumes and prices. However, the VBP policy could also inadvertently incentivize manufacturers to engage in strategic behaviors that may disrupt supply continuity. We develop a comprehensive model to analyze manufacturers' production planning policies under strategic, patient, and reliable modes and the strategy selection decision. For the manufacturer adopting the strategic mode, we establish optimal thresholds of the remaining commitments, above which it is optimal to breach the contract, and further develop a simple yet effective heuristic policy. We also characterize the optimal base‐stock ordering policies for the manufacturer under patient and reliable modes and derive upper bounds for optimal order quantities when commitment is extremely large. By numerical studies, we show the criticality of contract parameters in mitigating drug shortages, highlighting that high commitment levels encourage reliability due to steep default penalties, while low commitment levels lead manufacturers to fully fulfill the commitment before supplying higher‐priced alternatives. The mid‐range commitment, however, tends to foster strategic behaviors, increasing shortage rates. We apply Pareto analysis to demonstrate that, despite criticism for leading to shortages, VBP policies yield net positive outcomes within a wide range of terms in the Oseltamivir case, as the advantages of lower prices and the reinvestment of penalties into public welfare outweigh the drawbacks of manufacturers' strategic behaviors. Furthermore, increasing the commitment quantity and allowing a broader range of higher bidding prices could enable Pareto improvements over current practices. However, simply raising the commitment quantity alone, despite leading to higher breach penalties, is unlikely to yield these improvements without adjustments to other contract terms.