Transcript Health Economics ch9-1

Outline

Competitiveness of the pharmaceutical
industry

Conduct

Performance
Benefits of Drugs

Reduce mortality

Reduce morbidity/improve quality of life

Reduce cost of treating diseases
Industry Structure
# and size distribution of sellers
 Buyers’ side characteristics
 Barriers to entry
 Government regulation

Top 10 U.S. Prescription Drug Sellers, 2008
Company
Sales $b
Pfizer
20.5
GlaxoSmithKline
18.4
AstraZeneca
16.3
Johnson & Johnson
16.0
Merck & Co
15.5
Amgen
13.4
Hoffman-LaRoche (incl Genentech) 13.1
Novartis
12.4
Lilly
11.4
Sanofi-Aventis
11.0
http://www.imshealth.com
4-Firm Concentration Ratios 2002
Industry
4-firm CR %
Apparel
18.4
Basic Chemicals
18.3
Computer software
34.1
Food
14.8
Footwear
34.5
Furniture
18..7
Automobile
87.3
Pharmaceuticals
33.6
Can competition be accurate
measured at the industry level?
Most drugs are not substitutes to the
patient
 The relevant product market is the
therapeutic market

Only a few major drugs compete in most
therapeutic markets
Concentration ratios at this level are higher
than for industry as a whole

Concentration Ratios
for Therapeutic Markets, 2006
Therapeutic Market
Four-Firm Ratio
Antidepressants
87*
Antihistamines
99*
Antihyperlipidemics
73*
Antihypertensives
81*
Antivirals
80*
Gastrointestinal Diseases
91*
*Includes “Generics” as a top-4 firm
Express Scripts Drug Trend Report, 2006
Firms tend to make most profits from
a few key drugs
Top 3 Drugs as a % of Worldwide
6 Month Prescription Sales, 2007
Percent of
Company
Revenues
Glaxo Smith Kline
29.1
Pfizer
40.9
Johnson & Johnson
44.7
Percent of
Net Revenues
Wyeth
55.5
Bristol-Myers Squibb
47.5
Merck & Co.
44.3
The Buyer Side
Buyers of Prescription Drugs, 2007
Expend.
Source
($billions) Percent
Total
227.4
100.0%
All private
146.6
64.5
Out-of-pocket
47.5
20.9
Private insurance
99.1
43.6
All government
80.8
35.5
Federal
66.5
29.2
State
14.3
6.3
Prescription Drugs as a Percentage of U.S. National
Health Expenditures, 1960 - 2007
Share of Health
Expenditures
11%
9%
10.1%
9.8% 10.0% 10.0%
9.7%
9.4%
8.9%
8.8%
6%
10.3% 10.1%
7.3%
6.0%
4%
5.6%
4.7%
6.0%
5.0%
2%
0%
1960 1965 1970 1975 1980 1985 1990 1995 2000 2001 2002 2003 2004 2005 2006 2007
www.cms.hhs.gov
How 3rd parties influence drug demand
Even if consumers exert little influence
over drug choice, 3rd parties are
making the market more competitive
 Formularies - list of selected drugs
physicians may prescribe

 Used
by hospitals to limit inventories and
costs
 Used by most HMOs and many PPOs
 Used by many state Medicaid programs

Drug utilization review
 Used
by insurers to enforce formularies,
identify inappropriate prescribing practices

Government influence
 1990
Omnibus Budget Reconciliation Act Federal funding provided for drug only if
state Medicaid program receives
manufacturer rebate agreement

Government influence (cont.)
 1992
Veterans Health Care Act - price
discounts for Federal Supply Schedule,
VA, Dept. of Defense
 These
programs may restrict costs for
government, but drug firms may be forced
to raise nonfederal prices
“…managed care emphasizes less-expensive, preventive
types of treatment”
“The rate of growth for drugs to treat high blood
pressure and high cholesterol in certain managed-care
strongholds on the West Cost has gone off the charts”
WSJ 10/17/96
“Consumers in the $94
billion prescription drug
market are mostly
indifferent to price.
What will happen when
they all become budget
conscious?
Forbes 4/5/99
Pharmacy Benefit Managers
General Strengths

Intermediaries that purchase drugs from
manufacturers and pharmacies at a
reduced price for health insurers

PBMs provide drugs at lower costs
 Achieve
econ. of scale in pharmacy
benefits by serving multiple plan sponsors
 Large market share on buyer’s side 
stronger negotiating power w/ drug
companies
Pharmacy Benefit Managers
General Strengths

PBMs can use their patient information
to their strategic advantage
e.g. Medco’s 60m patients
 How drugs prescribed, used, impact on
disease
Can prevent inappropriate drug
interactions, under/over medication

Vertical Integration

Brand name drug companies were
purchasing PBMs
Estimated
Date
Acquirer
Target
Exp. ($m)
Nov-93 Merck
Medco
$6,600
May-94 SmithKline Beecham Diversified
$4,000
Jul-94 Eli Lilly
PCS Health
$2,925
Vertical Integration

Good or bad idea?
 Buy

the information, not the PBM
“Industry consultants and Medco competitors
argue that Merck could have bought that
information from Medco or others in the field
without buying the company.” NYT 8/5/93
 Critics
argue that PBMs will only serve to
lower prescription pharmaceutical prices
WSJ 2/2/98
Vertical Integration

Comments from Roy Vagelos, former
Merck CEO
 “In
classic terms of competition, we could see
that the power of the buyers was growing…PBMs
were…bringing together the person who chooses
the drug and the person who pays for the drug.”
 “Having
salespeople visit doctors’ offices does
not allow us to reach PBMs, HMOs, or plan
sponsors -- the major players in the emerging
market.”
Vertical Integration
 Merck
bought Medco as a response to
managed care
 Strategic
attempt to  market power. How?
Followup on patients w/ chronic illness
who may stop taking prescribed meds
 Position Merck drugs favorably on
formulary

 e.g.
lower patient copay, or lower cost to plan
sponsor
Vertical Integration
• In 2001, Medco accounted for $26b of
Merck’s $46b sales
• Medco filled 537m prescriptions in 2001
• But profit margins for Medco <3%
Vertical Integration

Regulators worried that patients and
employers would be hurt by this type of
vertical integration
 Regulators
required separate management of
drug sales and PBM operations

Merck spun off Medco in 2003
Role of the FDA

The Food and Drug Administration
approves a new drug before it can be sold
in the marketplace
 Also
determines whether drugs require a
physician prescription vs. OTC sales

The FDA requires extensive, costly testing
before approving a drug
 What
role?
is the economic argument for the FDA’s
Role of the FDA

Type 1 error: The FDA rejects the
application for a new drug that is truly safe
and effective

Type 2 error: The FDA approves a drug
that is unsafe or ineffective

If you worked for the FDA, which error
would you rather make?
 Why?
Role of the FDA

On Sept 20 2004, Merck announced it was
recalling Vioxx, its $2.5b-a-year arthritis
medicine

Was shown to double the risk of heart
attacks and strokes in long-term users

Merck lost 27% of its total market
capitalization in the stock market ($27b) in
one day
Role of the FDA

Can we compare the benefits of allowing
novel, risky drugs on the market to the
costs? (Olson, 2004)

“Novel” drugs offer therapeutic gains over
existing remedies
 1st
of a kind in a therapeutic area (e.g. Viagra)
 New additions to an existing class, which are
safer or more effective (e.g. Celebrex)
Role of the FDA

Adverse drug reactions (ADRs)
 Severe
reactions to drugs that are fatal, lifethreatening, permanently disabling or require
hospitalization
 Most ADRs filed by physicians and other
health professionals, reported to drug’s
manufacturer or the FDA
 Data is collected in the FDA’s spontaneous
reports system
Role of the FDA

The stock of novel drugs introduced 19901995 was estimated to result in 1.7m life
years saved
 (Predicted
deaths avoided per drug) x
(estimated life years gained per drug) x (#
novel drugs)

137,000 life years lost due to ADR deaths
during this time period
 (Predicted
deaths due to ADR per drug) x (life
years lost per drug) x (# novel drugs)
Role of the FDA

Losses due to ADRs may be
underestimated
ADR deaths in 1st 2 years after FDA
approval were considered
 ADRs may be underreported
 Many ADRs do not cause death, but result in
hospitalization or serious disability
 Only

Is the FDA being too lax or too lenient in
approving new drugs?
Barriers to entry

Government patents

Brand loyalty advantage

Control over a key input
Government Patents

Innovating firm gains the right to be sole
producer of a drug for legal maximum of
20 years
 Preserves
incentives for firms to undertake
risky and costly research and development
(R&D) that is socially valuable
 Rationale:
Monopoly restriction of output
better than having no output at all
Monopoly power of patents is not
always strong

Patents granted for chemical
composition, not therapeutic novelty
 Lipitor,
Crestor, and Zocor all compete in
the cholesterol-lowering drug market

Significant part of patent life may be
spent trying to get FDA approval
 “effective”
patent life = 8 years
Monopoly power of patents is not
always strong

1984 Waxman-Hatch Act - benefits for
both brand-name and generic
companies
 Effective
life of new drug patent can be
extended up to 5 years if FDA delayed
market introduction
 Fast approval process for generics:
eliminated proof of safety & effectiveness