THE cost to consumers of medicines like cough mixture could be inflated by millions of pounds annually because an Edinburgh firm exploits its exclusive right to make ingredients derived from opium to discriminate against smaller customers, a watchdog has claimed.

The Office of Fair Trading said Macfarlan Smith, which makes products like codeine on a site in west Edinburgh, took advantage of the fact it was the UK's only licensed producer of such substances to charge inflated prices.

The body estimated that the exclusive production licence for Macfarlan Smith, which has been in business since Victorian days, resulted in consumers paying around GBP3m too much a year for treatments.

It wants Macfarlan Smith to honour a commitment made to the old Monopolies and Mergers Commission in 1989 to give fuller information on prices to the drug producers and researchers to which it sells, to avoid smaller players being squeezed.

And in a move likely to stoke fears about the possibility of drugs getting into the wrong hands, the OFT says the government should open up the market for opium processing to other players across the UK.

The recommendations follow an investigation of the opium derivatives market that sheds fresh light on a relic of Scotland's manufacturing past, surviving in the shadow of the Heart of Midlothian football ground.

Macfarlan Smith, which has been part of the Johnson Matthey metals-to-pharmaceuticals empire since 2001, operates a plant producing derivatives made from concentrate of poppy straw. Most of this is imported under government licence.

The derivatives include morphine and codeine, which are sold to laboratories and manufacturers of products such as painkillers and cough medicines.

Macfarlan Smith has been the only UK producer since Boots dropped out of the market in 1990. The government has maintained strict limits on imports to maintain security of supply.

After Macfarlan Smith ended up with around 85per cent of the market in the late 1980s, the MMC completed an investigation of the derivatives trade.

This found that the company was able to "exploit its monopoly position by charging high prices and engaging in price discrimination at the expense of those customers buying smaller quantities".

Noting that the firm achieved very high levels of profitability, the commission concluded that the practices were against the public interest. It obtained an undertaking from Macfarlan Smith that the company would make price lists generally available to help improve the bargaining power of smaller players.

However, after reviewing the undertaking and developments in the market in recent years, the Office of Fair Trading expressed several concerns.

Following big growth in the production and use of derivatives since 1989, which was likely to continue, Macfarlan Smith's share of the market for reference opium derivatives had increased from 87per cent in 1986/7 to 91per cent in 2002.

Sales increased from 13.3 tonnes in 1989 to 44.8 tonnes in 2004.

The OFT found that practices that had concerned the old commission continued to befeatures of Macfarlan Smith's supply.

Estimating the UK market for opium derivatives at GBP31m annually, it said: "the detriment to consumers arising from present licensing policy is approximately GBP3m a year".

In a report published yesterday, the OFT criticised Macfarlan Smith for a "disappointing" record of compliance with the undertaking given to the MMC.

"The availability of a price list is unknown to the majority of Macfarlan Smith's customer base, contrary to what MMC had intended, and has not substantially constrained price discrimination, particularly against customers buying smaller quantities."

In May 1998 customers buying less than 10 kilograms of codeine phosphate were charged around GBP850 per kilo. Those buying 2000 kilos-plus were charged around GBP525 per kilo.

NHS laboratories were among those buyers that were put at a disadvantage.

However, noting that Macfarlan Smith had agreed to improve its compliance with the undertaking by publishing a price list for all bulk customers annually, the OFT put the onus on the government to cut the cost of derivatives by opening up the market for their production.

It has offered to advise ministers on developing a suitable licensing policy.

A spokesman for the Department of Trade and Industry said it was considering how to respond.

Ian Godwin, head of corporate communications, said Johnson Matthey was monitoring the situation.

"This is a recommendation by the OFT to the government and we can't comment on that."

The company acquired Macfarlan Smith after beating off strong competition to buy Edinburgh-based Meconic for GBP147m five years ago.