Transcript pharmaceutical_industryx

The Pharmaceutical Industry
PUBHHMP 7624
Wendy Xu
Spring 2016
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Overview
• Structure
• Conduct
• Performance
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Is the pharmaceutical industry concentrated?
• Pharmaceutical companies in U.S.
• A sizeable number of large companies coexist in the drug
industry
• 763 firms in 2007
• 4-firm concentration ratio: 35% in 2007
• Herfindahl Index (HHI): 457 in 2007
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Table 14.1 - The Largest Pharmaceutical Companies by U.S.
Sales, 2010
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Is the pharmaceutical industry concentrated?
• A therapeutic market is defined by only those drugs that
treat the same disease
• The therapeutic market is a measure of what the book termed the
“relevant product market” (RPM) in pharmaceutical industry
(Santerre & Neun pp246).
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Is the pharmaceutical industry concentrated?
• Concentration ratios based on static data on therapeutic
markets suggest a more concentrated market environment
• DiMasi (2000) found that the 4-firm concentration ratio for therapeutic
markets has been stable at about 36% since 1997: high concentration.
• The HHI for new molecular entities has been decreasing over the last 50
years
• Santerre and Neun characterize the therapeutic markets as mildly
concentrated
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The Buyer Side of the Pharmaceutical Market
• Is the buyer side of market concentrated leading to lower prices?
• The market has several segments where buyers are sufficiently important and
concentrated
• The following table presents the major buyers in pharmaceutical market
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Table 14.2 - Payers for Prescription Drugs, 2010
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The Buyer Side of the Pharmaceutical Market
• Is the buyer side of market concentrated leading to lower prices?
• Consumers directly pay for a relatively large percentage of drug costs
• Consumers pay for 19% of drug expenditures out-of-pocket in 2010. Over 20 years ago,
this share was over 60%.
• not responsible for choosing which specific drug to buy (unless it’s OTC)
• Clinicians, mainly physicians, prescribe 100% of prescription drugs, but do not
pay, so generally are not cost conscious
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The Buyer Side of the Pharmaceutical Market
• Is the buyer side of market concentrated leading to lower prices?
• Pharmacists make a consumer decision only if they determine which
therapeutic agent fills a prescription
• Pharmacists’ buyer role is limited to generic substitution.
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The Buyer Side of the Pharmaceutical Market
• Is the buyer side of market concentrated leading to lower prices?
• Health plans paid for 45% of expenditures in 2010
• Instead of letting physicians decide, health plans now establish formularies based on
effectiveness of drugs and prices
• Health plans further monitor physicians using drug utilization review
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The Buyer Side of the Pharmaceutical Market
• Government purchases 36% of prescription drugs in 2010
• Maximum Allowable Cost program, established in 1974, required generic
substitution in government health programs
• Medicaid, in the Omnibus Budget Reconciliation Act, OBRA 1990, extracted a rebate
from drug companies
• Rebate is the difference between the average price charged by drug firm to all its customers
and the price charged to the firm’s lowest priced other customer
• This most favored nation rule also said the rebate had to be at least 15% off the average price
• VA, in the Veterans Health Care Act of 1992, is required to negotiate prices and pay
no more than 76% of average price charged by drug manufacturer
• Medicare, in contrast, was prohibited from negotiating drug prices in the Medicare
Modernization Act of 2003
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The Buyer Side of the Pharmaceutical Market
• Pharmaceutical benefit managers (PBMs)
• PBMs negotiate drug prices for many health plans (so, many enrollees)
• PBMs also establish formularies and some now provide disease management
services
• Health plans pay a fee to PBM for this service
• PBMs are concentrated with a 4-firm concentration ratio of 80% in 2001
• So, is the buyer side competitive?
• It is difficult to assess because of market power on both sides
• Seller market power is enhanced, however, by barriers to entry
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Barriers to Entry
• Three 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
• Hatch-Waxman Act of 1984 gave up to a 5-year credit for time in the approval process,
but made competition by generics easier by not requiring them to prove safety and
effectiveness by conducting studies, just molecular equivalence would do.
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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
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Consumer Information and the Role of the FDA
• Correct FDA approval decision means
• FDA approves a safe and effective product
• FDA rejects an unsafe or ineffective one
• Effect of labeling of prescription drugs was to make their demand
more inelastic. Why is that?
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Consumer Information and the Role of the FDA
• Correct FDA approval decision means
• FDA approves a safe and effective product
• FDA rejects an unsafe or ineffective one
• Effect of labeling of prescription drugs was to make their demand
more inelastic. Why is that?
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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
• FDA approves a drug that is unsafe or ineffective
• Highly visible
• Incentive to reject rather than accept a drug
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The Conduct of the Pharmaceutical Industry
• 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
• 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
• Distribution of promotional activity costs in 2010
• 60% for detailers (drug reps)
• 37% for direct to consumer advertising
• 3% for journal ads
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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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Promotion of Pharmaceutical Products
• In 2004, the NY Times did a story about Schering-Plough paying
$10,000 per physician for providing “consulting” services!
• Is this promotional activity, too?
• Reading: The Drug Pushers
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Product Innovation
• Improve quality of life and extending lives
• The drug companies use the costs of innovation to justify the large
profits that they have traditionally earned
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Product Innovation
• What is the R&D process and how long does it take?
• 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
• What determines the amount of R&D expenditures?
• 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
• Do bigger firms innovate more than smaller firms?
• 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
• 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
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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
• 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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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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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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Table 14.3 – Return on Assets and Stockholder Equity for Drugs and all
Manufacturing Companies, Various Years
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End of Session
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