On the Use of Overt Anti-Counterfeiting Technologies

Many pharmaceutical companies use overt anti-counterfeiting technologies (OACTs), such as holograms, to fight counterfeiters. An OACT is typically implemented on the drug packaging, which makes it difficult for counterfeiters to produce convincing copies and easy for patients to tell the difference between authentic and counterfeit medicines. I consider a model in which an authentic firm sells its drug at a reliable source and counterfeiters and illegitimate genuine sellers sell their drugs at a dubious source. The authentic firm chooses an OACT to combat counterfeiters. I show that there may be an inverted U-shaped relationship between the complexity of the OACT and the magnitude of counterfeit medicine purchases. The nature of this relationship is a consequence of an OACT engendering two opposing effects. On one hand, adopting an OACT imposes an entry cost on counterfeiters, causing fewer counterfeiters to enter the dubious source; as a result, the drugs at this source have a greater chance of being genuine (a counterfeiters’ entry-dampening effect). On the other hand, more patients head to this dubious source rather than the reliable source owing to the increased chance of obtaining a genuine drug (a patients’ demand-enhancing effect). When the selected OACT is sufficiently complex to replicate, the former effect overrides the latter and thus the problem of counterfeit purchasing is relieved. However, when the OACT is not adequately sophisticated, the latter effect more than offsets the former. This leads to an anti-counterfeiting trap: the use of a rudimentary OACT may beget more counterfeit purchases. This result offers an understanding to the phenomenon that despite enormous spending on the upgrading of OACTs in recent years, annual global sales of counterfeit drugs have actually risen. I also find that using an OACT may result in higher prices for both counterfeit and authentic drugs. Furthermore, I demonstrate that, at the optimum, an authentic firm may find it more profitable to employ a mediocre OACT, whereas it may not use any OACTs if its price is regulated.