When you buy a generic pill in Germany, France, or Spain, its price isn’t just decided by the manufacturer or local market demand. It’s often pulled from a list of prices in other countries. This is called international reference pricing - and it’s how most of Europe keeps generic drug costs low. But how exactly does it work? And why do some countries see shortages while others save billions?

What Is International Reference Pricing?

International reference pricing (IRP), also known as external reference pricing, is when a country looks at what other nations charge for the same generic medicine and uses that to set its own price. It’s not about what the drug costs to make - it’s about what others are paying. This system became common in the 1980s, starting with Italy, Spain, and Portugal, as governments tried to stop pharmaceutical spending from ballooning.

Today, 34 out of 38 high-income countries use some version of IRP. But for generic drugs, it’s not just about comparing prices across borders. Most European countries use something called internal reference pricing instead. That means they group together all generic drugs that treat the same condition - like all versions of metformin for diabetes - and set one reimbursement price based on the cheapest one in the group. Any drug in that group that costs more gets less coverage. Patients might still buy it, but they pay the difference.

How Countries Choose Which Prices to Reference

Not every country looks at the same set of reference nations. Western European countries typically compare prices from France, Germany, Italy, Spain, and the UK. Eastern European countries often use Austria, Germany, and the Netherlands. The choice matters. If you pick countries with very low prices, your own prices will drop fast - sometimes too fast.

Most countries calculate the reference price using the median or average of their reference basket, not the lowest price. Why? Because if you base your price on the cheapest drug in the world, you risk making it impossible for manufacturers to stay in business. The European Federation of Pharmaceutical Industries and Associations (EFPIA) recommends this approach for fairness and predictability.

Some countries tweak the formula. Switzerland, for example, sets generic prices at two-thirds of the average international price and one-third based on its own domestic prices. That way, it doesn’t get dragged down by the lowest-cost countries but still benefits from lower prices than its neighbors.

Internal vs. External Reference Pricing for Generics

There’s a big difference between how IRP works for brand-name drugs versus generics. For patented drugs, countries often use external reference pricing - comparing prices across borders directly. For generics, most use internal reference pricing.

Why? Because generics are interchangeable. A 500mg metformin tablet from one maker works just like another. So instead of comparing prices between countries, regulators group similar drugs together and cap the price at the lowest cost in the group. Germany’s AMNOG system, for example, reimburses all drugs in a therapeutic group at the lowest price plus a 3% margin. That pushes manufacturers to compete on price, not marketing.

In the Netherlands, it’s even more aggressive. They combine internal reference pricing with mandatory discounts and tendering. As a result, generic prices are 65-85% lower than the original brand drugs. That’s one reason why generic use in the Netherlands is over 90% - the highest in Europe.

What Happens When Prices Drop Too Low?

Lower prices sound great - until patients can’t find the medicine. Greece is a cautionary tale. During its financial crisis (2010-2018), the government slashed generic drug prices using IRP, updating them every quarter. Prices fell by over 40% in some cases. But manufacturers couldn’t make a profit. By 2015, 37% of generic medicines experienced shortages. Pharmacies had to substitute other brands, and patients sometimes waited days for their prescriptions.

Portugal saw the same thing. In 2019, 22 generic products disappeared from the market because the prices set by IRP didn’t cover production costs. This isn’t just about big companies leaving - it’s about small manufacturers who can’t absorb the losses. As Simon-Kucher & Partners warned, strict IRP without considering manufacturing costs leads to market exit.

Even in countries without shortages, there’s a trade-off. A 2019 study found that countries relying solely on IRP for generics saw 22% greater price reductions - but also 18% longer delays in bringing new generic versions to market. Manufacturers wait to launch because they know prices will be capped low from day one.

How the U.S. and Canada Handle Generic Prices

The United States doesn’t use international reference pricing for generics in federal programs like Medicare or Medicaid. Instead, prices are driven by competition, pharmacy benefit managers (PBMs), and bulk purchasing. But some states are experimenting. Colorado’s Medicaid program started using reference pricing for generics in 2021, and it saved 12-15% on drug costs, according to CMS data.

Canada takes a different path. The federal Patented Medicine Prices Review Board (PMPRB) uses IRP for brand-name drugs - but not for generics. Generic prices are set by individual provinces through tendering. Ontario and Quebec hold competitive bids where manufacturers submit lowest-price offers. The province picks the winner and locks in the price for a year. This system gives provinces more control and avoids the pitfalls of international price dragging.

Who Benefits and Who Loses?

Patients in countries with strong IRP systems generally pay less. A 2021 OECD survey showed 78% of patients were satisfied with generic substitution under IRP. But 34% worried the cheaper versions weren’t as good - even though there’s no clinical difference.

Pharmacists see the effects daily. In Spain, internal reference pricing increased generic substitution from 52% in 2010 to 89% today. But 63% of pharmacists reported occasional shortages of the lowest-priced brand, forcing them to switch patients to alternatives - sometimes without their consent.

Manufacturers are caught in the middle. Teva reported a 9% revenue decline in its European generics division between 2020 and 2022, even though sales volume grew by 15%. Sandoz, on the other hand, said well-designed IRP helped them expand in 18 countries. The difference? Companies that invested in cost-efficient production and high-quality manufacturing did better.

Hospitals benefit too. Germany’s internal reference system reduced administrative burden by 37%, because procurement teams didn’t have to negotiate dozens of individual prices. They just bought from the approved list.

The Future of Generic Drug Pricing

IRP isn’t going away - it’s getting smarter. France launched a new system in January 2023 called dynamic reference pricing. Instead of setting prices once a year, it adjusts them quarterly based on which generic brands are selling the most. If a cheaper version suddenly dominates the market, its price gets pulled down further. Early results show an extra 8.2% savings.

The European Commission is testing a European Reference Pricing Platform, launched in April 2023. It’s a pilot that shares pricing data across seven countries for 15 generic medicines. If it works, it could expand to 100 drugs by 2025. The goal? More transparency, fewer surprises, and smarter price setting.

But experts warn that current systems aren’t ready for complex generics - drugs like inhalers, injectables, or biosimilars that cost nearly as much to develop as brand-name drugs. A 2023 RAND Corporation study found that strict IRP discourages investment in these products. The OECD now recommends tiered reference groups: simple generics get the lowest prices, complex ones get higher, fairer rates.

What Works Best?

Professor Panos Kanavos from the London School of Economics found that countries using 5-7 reference countries got the best balance: average price reductions of 28% with 97% drug availability. Countries using more than 10 saw diminishing returns - only 31% price drop, but 12% higher shortage rates.

Here’s what successful IRP systems have in common:

• They use internal reference pricing, not just external comparisons.
• They set reference prices based on median or average, not the lowest.
• They limit their reference basket to 5-7 similar countries.
• They update prices annually or semi-annually - not quarterly.
• They allow small margins for quality and manufacturing complexity.

When these rules are followed, IRP works. It lowers costs without breaking supply chains. When ignored, it leads to shortages, delays, and lost innovation.

What Patients and Providers Should Know

If you’re on a generic drug, your price might be lower because your country is comparing it to what France or Germany pays. That doesn’t mean the drug is less effective. In fact, most generics are identical in quality to brand-name versions.

But if your pharmacy says your usual brand is out of stock - and the replacement is cheaper - it’s likely because of IRP. You have the right to ask for your original brand, but you may pay more out of pocket.

For prescribers, understanding IRP helps you choose wisely. In countries with mandatory substitution rules, you may be required to prescribe the lowest-priced option if the price difference exceeds 20%. That’s not about cost-cutting - it’s about system design.

For policymakers, the lesson is clear: IRP is powerful, but it’s not a magic button. It needs careful design, monitoring, and flexibility. Otherwise, the savings come at the cost of access.

Next Steps for Policymakers and Patients

If you’re a policymaker, start with a small pilot. Pick one therapeutic group - like statins or antibiotics - and test internal reference pricing with a 5-country basket. Track shortages, substitution rates, and manufacturer responses. Don’t rush to apply it to all generics.

If you’re a patient, know your rights. If your pharmacy switches your generic brand, ask why. If you’re concerned about quality, talk to your doctor. Most generics are just as safe and effective - but you deserve to know what’s being substituted.

For manufacturers, the message is simple: adapt or exit. If you’re in a country with strict IRP, focus on efficiency, quality, and cost control. If you make complex generics, push for tiered pricing systems that recognize your higher costs. The future of generics isn’t about the lowest price - it’s about sustainable access.