The Pharmaceutical Industry
Part 2
Professor Vivian Ho
Health Economics
Fall 2009

Pharmaceutical Industry Conduct
 Pricing
 Does more intense competition   drug prices?
 Promotion
 Does drug advertising promote or impede competition?
 Product innovation

 Are large firms necessary for drug innovation?
Preview: Empirical evidence indicates that competition is at work, but the industry does not exhibit perfect competition .

Pricing Behavior
 Can the brand-name firm maintain its price once its patent expires and generics enter?
 After patent expiration, each 10% increase in the price differential for brand-name drugs relative to generics resulted in only a .5% drop in market share for the brand-name drug.
(Hurwitz & Caves, 1988)
 Average price differential between brand-name and generic firms = 127%, but brand name market share = 63.4%.

Pricing Behavior
 The longer the brandname drug’s effective patent length, the more market share it preserved after patent expiration.
 The arrival of an additional supplier was estimated to reduce the brand-name drug’s market share by 1.25 percentage points.

Pricing Behavior

Branded drugs’ prices 
11% 2 years after generic entry.
(Grabowski & Vernon 1992)
 Yet brand-name drugs lost 1/2 of market share.
 Average market price fell to 79% of preentry price.

Pricing Behavior
 Brand-name firms segment the market.
 Remaining customers relatively price insensitive.
 Inelastic demand curve allows them to maintain price.
 These 2 studies suggest that generic drug prices are substantially lower than brand-name prices.

Express Scripts 2007 Drug Trend Report

Promotion Strategies
 Promotion Magnitude:
 Research-based firms spend as much as
20-30% of sales on promotion.
 70% pharmaceutical salespersons
(detailing).
 27% advertising.
 3% direct mail.
 Impact:
 22,000 drugs on market
 timely, valuable information.
 May impede competition.

Direct-to-Consumer Prescription
Drug Advertising: Bane or Boon?
Richard L. Kravitz, MD, MSPH
UC Davis Center for Health Services
Research in Primary Care

A brief regulatory history


1981: industry shows interest in advertising directly to consumers
1983 –1985: FDA obtains voluntary moratorium on DTC advertising
 1985: moratorium lifted
 1990: DTC advertising begins in earnest
 1997: TV advertising made feasible through FDA policy change

Promotional spending by pharmaceutical manufacturers

Are DTC ads reaching consumers?

Ads are read and acted upon
 56% of Sacramento-area adults have read a
DTC ad carefully from beginning to end
 35% have asked their doctor for more information because of a DTC ad
 19% have asked for a prescription due to an ad

Misconceptions abound
 50% believe ads subject to prior review

43% believe only “completely safe” prescription drugs can be marketed
DTC; 21% that only “extremely effective” drugs can be so marketed
 22% believe that advertising of prescription drugs with serious side effects has been banned

Are DTC ads educational?

The Industry Perspective
“ By greatly increasing the likelihood that patients will seek help for their medical problems and receive a safe and effective prescribed medicine, DTC advertising will…play a very real role in enhancing public health.”
-Alan F. Holmer, President, Pharmaceutical Research and Manufacturers of America, JAMA 281:380,1999

A Contrarian View
“Extending the scope of already ubiquitous promotions about ‘post-nasal drip,’ ‘unsightly rashes,’ or ‘cures for baldness’ has little to do with educating patients or relieving suffering.
It will, however, inevitably drain healthcare dollars, dramatically increase unnecessary prescribing, and strain patient-doctor relationships.”
--JR Hoffman and MS Wilkes, BMJ 318:1301, 1999

Content analysis of print ads
 All DTC ads appearing from 1989 through 1998 in 18 popular magazines
 Selection of publications based on circulation

Results
Medical
Condition
Codes
Condition Name
Symptoms
Precursors
Prevalence
Misconceptions
Mechanism of Action
Competing Treatments
Supportive Behaviors
Treatment
Codes
Onset of Action
Treatment Duration
Success Rate
0% 20% 40% 60% 80% 100%

Influence on prescribing decisions: a bi-national study
 Cross-sectional cluster survey in
Sacramento (CA) and Vancouver
(CANADA)
 78 primary care physicians
 1431 patients (61% of those attending on preset clinic days)

Patient requests and physician prescribing
 Patients requested prescriptions in 12% of visits (MD report)
 42% of requests were for advertised products
 74% of those requesting drugs received them
(similar for advertised and non-advertised drugs)
 Patients requesting a prescription much more likely to receive one (AOR 8.7, 95% CI 5.4-
14.2)

Provoking clinical ambivalence

“If you were treating another similar patient with the same condition, would you prescribe this drug?”

Percent “possibly” or “unlikely”
 Rx not requested: 13%
 Any drug requested: 49%
 Advertised drug requested: 70%

Summary of Katz Studies
 DTC ads are reaching consumers
 Education is a side effect of promotion
 DTCA-induced requests influence prescribing
 A true reckoning of public health benefits and harms has not occurred

Product Innovation

Product Innovation

www.phrma.org
Product Innovation

Product Innovation
 Innovation is very risky and time consuming.
 R&D process takes many years.
 Only a small fraction of new drug discoveries are eventually marketed.
 75% of NCEs in Phase 1 go to Phase 2.
 36% of NCEs in Phase 1 go to Phase 3.

Capitalized Cost per
Approved Drug
 R&D costs are capitalized to the date of marketing approval
 The cost-of-capital is based on a CAPM analysis of the pharmaceutical industry
 An 11% real cost-of-capital was utilized for the period under study

Out-of-Pocket and Capitalized Costs per Approved Drug
900
800
700
600
500
400
300
200
100
0
121
336
282
466
403
Pre-Clinical Clinical
Out-of-Pocket Capitalized
Total
802
J. DiMasi, R. Hansen, and H. Grabowski, “The Price of
Innovation: New Estimates of Drug Development Costs”, Jan
2002

Pharmaceutical Industry Performance
Does the absence of perfect competition
 higher prices & restricted output?
Urban Consumer Price Inflation Rates
Year All Items Prescription Drugs*
1970-79
1980-89
1990-94
1995
2000
2003
2005
2007
2008
7.1
5.6
3.6
2.8
3.4
2.3
3.4
2.8
3.8
3.6
9.6
6.9
1.9
4.4
3.1
3.5
1.4
2.5
*2000 - 2005 includes prescription drugs and medical supplies.

IMS Health
DRUG SPENDING INCREASED
5.4% from 2004 to 2005
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
-1.00%
-2.00%
4.1%
2.3%
-1.1%
2004-2005
5.4%
Price Inflation
New Drugs
Utilization &
Mix
TOTAL

Cautionary note on inflation
 The inflation rate calculated by BLS is based on a price index, which may overstate the true
 in drug costs.
 Price index
 the relative cost of purchasing a fixed
“basket” of drugs in year t, vs. the costs of same basket in a base period.
Price Index t
=

 i i
N
N

1

1 p it x io p io x io i

1 ,....
N drugs

Cautionary note on inflation

BLS “basket” undersamples new drug products, which generally have smaller price increases than older drugs.
 BLS treats generics as new products, not as substitutes for more expensive drugs.
 BLS uses list rather than transactions prices.

BLS doesn’t adjust prices to reflect quality improvements.

Are profits in the drug industry “too high?”
Return on Assets for Pharmaceutical
Companies in the Fortune 500
2008 Profits as % of Assets Rank Company
29 Johnson & Johnson
46 Pfizer
80 Abbott Laboratories
103 Merck
110 Wyeth
120 Bristol-Myers Squibb
122 Eli Lilly
138 Schering-Plough
168 Amgen
15.2
7.3
11.5
16.5
10.0
17.8
-7.1
6.8
11.5
The Pharmaceutical industry ranked 3 out of 53 industries with an ROA of 11.5.

Are profits in the drug industry too high?
 Under standard accounting practices, R&D is written off as a current expense.
 But R&D affects revenues for years to come.
 Rate of return on investment is calculated using an asset base that improperly excludes intangible R&D.
 Should capitalize R&D outlays & depreciate them over appropriate time periods.
 Accounting figures overstate the rate of return on assets for drug companies.