External and Internal Reference Pricing for Medicines

Reference pricing is one of the most widely used approaches governments and health insurers adopt to manage what they pay for medicines. The term refers not to a single mechanism but to a family of policies that benchmark a medicine's price against something else — either prices in other countries, or prices of therapeutically similar products within the same market. Understanding how these benchmarks work helps explain why the same medicine can cost very different amounts in different places, and why reimbursement decisions sometimes appear inconsistent to patients and prescribers.

The two main variants are external reference pricing, also called international reference pricing, and internal reference pricing, sometimes called therapeutic or reference-based pricing. Both aim to make medicine pricing more structured and cost-contained, but each comes with well-documented strengths and criticisms.

External reference pricing

External reference pricing works by comparing the price of a medicine in one country to its price in a selected basket of other countries. A health authority might gather manufacturer or wholesale prices from a group of reference countries and then set the local maximum price at the average, the median, or the lowest of those figures. The choice of comparator countries and the formula used vary widely: some systems apply the lowest price to push costs down aggressively, while others use an average to avoid extremes.

This approach is particularly common in Europe, where many countries reference prices across borders, and in smaller markets that lack the bargaining power to negotiate prices independently. It is attractive because it is relatively inexpensive to administer and draws on negotiation outcomes already achieved elsewhere. However, external reference pricing has notable weaknesses. Manufacturers, knowing that a low price in one country can pull down prices in every country that references it, may delay product launches in low-price markets or avoid them altogether. It can also produce surprising outcomes when countries with very different income levels and health systems are grouped together, and it does not directly assess whether a medicine offers good value for money.

Internal reference pricing

Internal reference pricing takes a different approach. Instead of looking across borders, it groups medicines that are therapeutically equivalent — broadly meaning they work in similar ways for the same conditions — and sets a single reimbursement rate for the entire group. That rate is often based on the cheapest product in the cluster or an average across the cluster. If a patient or prescriber chooses a medicine priced above the reference rate, the difference is typically paid out of pocket or covered by supplementary insurance.

This mechanism is designed to stimulate price competition among interchangeable products, particularly once generic versions enter the market. It can be a powerful tool for containing reimbursement budgets and steering prescribers and patients toward lower-cost options. But it depends on the assumption that medicines grouped together are clinically interchangeable, which is not always straightforward. Differences in formulation, dosing frequency, side-effect profiles, or individual patient response can matter in practice, even when products are classified as therapeutically equivalent.

Strengths and criticisms

Both forms of reference pricing share a common appeal: they provide an administratively simple way to anchor prices to something external, rather than relying solely on what a manufacturer chooses to charge. For public payers and insurers operating under tight budgets, this can be an important safeguard. External reference pricing is especially useful for smaller countries that would otherwise have little leverage in price negotiations, while internal reference pricing can help direct spending toward the most affordable options within a therapeutic class.

The criticisms, however, are substantial. External reference pricing can contribute to launch delays and reduced availability in smaller or lower-income countries, and it may cause prices to converge in ways that do not reflect local purchasing power. It can also create circularity problems when countries reference each other's prices. Internal reference pricing, meanwhile, may discourage pharmaceutical companies from investing in incremental improvements within a therapeutic class, since clinically meaningful differentiation is effectively priced out by the reference rate. Both approaches are also criticised for paying limited attention to the actual therapeutic value or cost-effectiveness of a medicine, which is the focus of health technology assessment.

Combining approaches in practice

In practice, most countries that use reference pricing combine it with other tools rather than relying on a single mechanism. Negotiated discounts, health technology assessment, competitive tendering for generics, and regulated wholesale or pharmacy mark-ups all play a role alongside reference benchmarks. South Africa, for example, regulates medicine prices through the Single Exit Price framework rather than a reference-pricing system, and all medicines must be registered with SAHPRA before they can be sold. The broader question of how local prices compare with those in other countries remains one that researchers and policymakers continue to examine, and tools that make registered medicine prices searchable — such as HealthSA — can help bring greater transparency to these comparisons.