Assignment 6-10
beegirlie61
SanterreNeun_Chapter14forassignment9.pptxChapter 14
The Pharmaceutical Industry
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Number and Size Distribution of Sellers
Pharmaceutical companies
A sizeable number of large companies coexist in the drug industry
A multitude of lesser-known, smaller firms exist
Manufacture and retail generic drugs
Little, if any, emphasis on new drug discovery
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Table 14.1 - The Largest Pharmaceutical Companies by U.S. Sales, 2010
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Number and Size Distribution of Sellers
U.S. pharmaceutical industry
763 firms in 2007
Appears to be reasonably competitive from a structural perspective
Therapeutic-market definition offers a more appropriate approach to defining the RPM for drugs
Concentration ratios based on static data on therapeutic markets suggest a more concentrated market environment
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Number and Size Distribution of Sellers
Pharmaceutical industry
Mildly concentrated
A few drug companies tend to dominate most therapeutic markets
Dominant positions may not be very permanent
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Number and Size Distribution of Sellers
Market shares are reasonably close among the top ten drug companies
This cannot by itself identify whether drug companies possess significant market power
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The Buyer Side of the Pharmaceutical Market
Degree of buyer concentration
Number and size distribution of buyers
Market is relatively fragmented
Consumers directly pay for a relatively large percentage of drug costs
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Table 14.2 - Payers for Prescription Drugs, 2010
8
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The Buyer Side of the Pharmaceutical Market
Realized demand for pharmaceutical products
Consumers - not responsible for choosing which specific drug to buy
Demand depends on-
Consumer tastes
Behavior of physicians who prescribe these drugs
Retail and hospital pharmacists who dispense the prescriptions
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The Buyer Side of the Pharmaceutical Market
Classes of drugs
Over-the-counter (OTC)
Available for self-medication
Prescription (Rx)
Available only by a physician’s prescription
Dominant type sold today
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The Buyer Side of the Pharmaceutical Market
Physicians - prescribe medicines
Lack incentive to make cost-effective choices
Result: high-priced, brand-name drug when an equally effective lower-priced generic is available
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The Buyer Side of the Pharmaceutical Market
Third-party influences on the demand for pharmaceutical products
Formularies
Drug utilization review
Required generic substitution
Federal Maximum Allowable Cost (MAC) program
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The Buyer Side of the Pharmaceutical Market
Price controls on drugs sold to Medicaid patients
Omnibus Budget Reconciliation Act of 1990
Veterans Health Care Act of 1992
Pharmacy Benefit Management Companies
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Barriers to Entry
Barriers to entry into the pharmaceutical industry
Government patent
First-mover or brand-loyalty advantage
Control over a key input
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Barriers to Entry
Government patent
Gives the innovating firm the right to be the sole producer of a drug product for a legal maximum of 20 years
Does not guarantee that the company will remain perfectly insulated from competition
Effective duration is often less than 20 years because the FDA takes a number of years to approve a product for commercial introduction
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Barriers to Entry
First-mover or brand-loyalty advantage
Because the quality of a substitute generic product is generally unknown
Generic drugs - experience goods
Confers market power on the innovator of a new product
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Barriers to Entry
Control over a key input
Specific chemical or active ingredient
New competitors require access to the input
Originating firm may sell it to the new entrants only if it is profitable to do so
If replication is difficult or costly
New firms may find it unprofitable to enter the industry
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Consumer Information and the Role of the FDA
Consumers - face 3 risks when directly purchasing pharmaceutical products
Overpaying or receiving a pharmaceutical product of inferior quality
Adverse reaction to a drug may lead to sickness or death
Purchase the wrong drug or take the wrong dosage and therefore fail to recover from an illness or injury
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Consumer Information and the Role of the FDA
FDA - protect consumers from the risks associated with drug purchases
Determining drug status: over-the-counter or prescription status
Must approve a new drug before it can be sold in the marketplace
Correct approval decision means
FDA approves a safe and effective product
FDA rejects an unsafe or ineffective one
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Consumer Information and the Role of the FDA
Uncertainty, FDA - two types of errors
Type 1 error:
FDA rejects the application for a new drug that is truly safe and effective
Less visible
Type 2 error:
FDA approves a drug that is unsafe or ineffective
Highly visible
FDA
Incentive to reject rather than accept a drug
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The Conduct of the Pharmaceutical Industry
Pricing behavior
Potential for noncompetitive pricing
Price drug products above the marginal costs of production and generate economic profits
First-mover advantages
Promotion expenditures
Reinforce the habit-buying practices of many buyers, especially physicians
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Pricing Behavior
Empirical evidence
Prices of brand-name and generic products lower when higher substitutes available
Prices of branded drugs sometimes rise upon generic entry
Goodwill established during the patent period allows established firms to maintain a large market share despite generics
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Pricing Behavior
Empirical evidence
Price accounts for most of the variation in a generic company’s market share
Therapeutic novelty of a drug influences pricing strategy over time
High brand-name profit margin at the time of generic entry increases the number of entrants fairly quickly
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Promotion of Pharmaceutical Products
Pharmaceutical promotion strategies
Leffler (1981), Hurwitz and Caves (1988), and Caves et al. (1991)
Support both the informational and persuasion effects of pharmaceutical promotion
Informational effect
Advertising intensity is greater for newer and more important pharmaceutical products
New entrants’ promotion expenditures helped them expand their market shares
Increased generic competition results in less advertising by the innovator
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Promotion of Pharmaceutical Products
Pharmaceutical promotion strategies
Empirical evidence, Leffler (1981), Hurwitz and Caves (1988), and Caves et al. (1991)
Persuasion effect
Detailed targeting of younger physicians occurs for older products
Leading firms’ promotion expenditures preserved their market share from new generic entrants
Generic firms gain relatively small shares despite their huge discounts
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Product Innovation
New drug development is a sequential process
Review development status of a drug; decide to continue or abandon the project
Expected revenues depend on
Therapeutic properties of the drug, the size of the target market, and the number of substitute drugs
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Product Innovation
Anticipated costs depend on
The frequency and severity of adverse reactions to the drug and the projected additional development, marketing, distribution, and production costs
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Figure 14.1 – R&D Intensity of Major Pharmaceutical Companies, 1970-2009
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Product Innovation
Grabowski and Vernon (1981), Vernon (2005), and Lichtenberg (2004)
Determinants of R&D Spending
The amount of expected economic profits T
The difference between the expected future streams of revenues and costs.
The contemporary profit rate
Past R&D success
Market value of the firm as a measure of expected revenues
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Product Innovation
Firm Size and Innovation
Larger firms tend to face a greater incentive to undertake successful R&D activities than smaller firms:
Resource capability
Risk absorption
Research economies
Larger firms also face greater bureaucratic red tape - stifles creativity
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Product Innovation
Acs and Audretsch (1988)
Larger firms have an innovative advantage:
Capital intensive, advertising intensive, and relatively concentrated industries
Smaller firms have an innovative advantage:
Industries with total innovation and the use of skilled labor
Some, but not many, large firms exist
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Product Innovation
Pharmaceutical innovation
Mixture of firm sizes foster innovation
Innovativeness of smaller firms is greatest when large firms dominate in an industry
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The Relative Price Inflation Rate of Pharmaceutical Products
1970s
General price inflation rate - outpaced the prescription drug inflation rate
Real or relative drug prices declined
1980s
Quick rise of real drug prices
1990s
Drug price inflation rate tended to track the general price inflation rate during 1993–1996
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The Relative Price Inflation Rate of Pharmaceutical Products
1997 to 2005
Drug prices increased faster than the general price level
The difference in inflation rates was slight in 2003, 2004, and 2005
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The Relative Price Inflation Rate of Pharmaceutical Products
2006-2007
General price inflation rate exceeded the drug price inflation rate
Quality-adjusted price inflation rates may be lower than the BLS reported rates
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Figure 14.2 – Drug and General Price Inflation Rates, 1996-2011
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Output of New Pharmaceutical Products
New chemical entities, NCEs
Improve quality of life by relieving pain
Significantly reduced deaths from many diseases
Tuberculosis, kidney infection, and hypertension
Virtually eliminated diseases such as whooping cough and polio
New drug cost offset theory
Reduce the cost of treating diseases
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Output of New Pharmaceutical Products
Lichtenberg (2005)
New drugs have a strong positive impact on the probability of survival
People can expect to live one week longer each year because of new drugs
Produce an additional life-year at an incremental cost of about $6,750
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Figure 14.3 – Annual Number of New Molecular Entities, 1980-2010
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Table 14.3 – Return on Assets and Stockholder Equity for Drugs and all Manufacturing Companies, Various Years
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Profits in the Pharmaceutical Industry
High profits
Patents, brand loyalty, and an inelastic demand for drugs
Profitability of drug firms is twice that of the manufacturing industry average:
Unusually high R&D risks and marketing outlays
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Provisions of the Patient Protection and Affordable Care Act (PPACA) of 2010 Relating to the Pharmaceutical Industry
Health insurance mandate should increase the demand for all type of drugs
Firms manufacturing or importing branded drugs will be taxed on branded-drug sales
A generic drug can be approved despite last-minute changes to the labeling of the listed drug
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