Pioneers, Imitators, and Generics – A Simulation Model of
Schumpeterian Competition
The authors develop a computer simulation model of R&D competition in new
product introductions and apply it to the pharmaceutical industry
There are two qualitatively different types of R&D strategies in the model:
“pioneering” and “imitative”
Pioneering R&D involves the development of a new family of products with the
potential for very significant therapeutic advances and commercial success:
risky but potentially very rewarding
Imitative R&D involves investigating a known family of products to produce
incremental improvements: less risky but less rewarding
A third type of strategy that involves no innovation is “generic competition,”
which the authors consider but do not endogenize
The Goal: Policy Impacts
The parameters are based on data for the U.S. pharmaceutical industry
during the 1970s
The authors examine the sensitivity of innovation levels to the rate of
generic competition, regulatory review times, and patent lives
They are particularly interested in how changes in government policy
influence the rate of innovation and the relative positions of the
different types of firms
General Description of the Model
Competition centers around investments in R&D projects
The firms in the model can be characterized as collections of ongoing projects in
various stages of the life cycle: discovery, development, market life, removal
from the market
Each year, the firm must make various decisions about its portfolio of R&D
projects: whether to continue funding each one, start new ones, exit the
industry, etc.
Completed R&D projects receive random qualities that determine commercial
potential, and the path of sales follows a life cycle pattern (rising initially, then
stable, then declining)
The pattern of sales if subject to change as a result of imitative entry
General Description, cont.
The earnings from successful R&D projects are used to fund future R&D
Firms engaged in pioneering R&D plow back a target percentage of their
total earnings into R&D, subject to several constraints
Firms engaged in imitative R&D base their R&D expenditures on
expected and realized earnings from R&D
They assume firms specialize and either pursue pioneering R&D or
imitative R&D
R&D and Profits
Pioneering and imitative R&D have similar features, but the expected
value of R&D costs and market sales are greater for pioneers
A pioneering strategy requires a discovery phase that imitators do not have
to perform
Consequently, the R&D process is longer and more costly for pioneering
firms
Pioneering R&D has a lower probability of success
Pioneering firms face a more highly skewed distribution of market sales
R&D Competition Across Market Classes
All competition takes place in the context of particular industry submarkets
The allocation of R&D budgets across submarkets is important
They assume the probability that a pioneering firm launches a product in any
particular submarket is equal across submarkets
However, any submarket that has a major product breakthrough (a blockbuster) is
assumed to have a temporary depletion of the stock of opportunities which
prevents that class from having another such winner in the immediately
subsequent years
Imitators target their R&D allocations to submarkets with recent market successes;
their new product launches are a lagged stochastic function of the market
introduction pattern of the pioneers
An imitator’s payoff is a function of the sales of the pioneer it is imitating and the
number of competing imitative products entering the submarket
Pioneers new product introductions are more market expanding and less
redistributive than imitator’s R&D
R&D Expenditure Functions
Pioneering firms plow back a percentage of their net revenues into R&D, subject
to constraints on the growth of R&D and the funding of ongoing projects
The pioneers operate with a target R&D expenditure to revenue ratio
They use the earnings targeted for R&D first to fund ongoing projects and then to
initiate new projects
A constraint on R&D growth is incorporated to avoid unrealistically sharp
increases in R&D from large increases in net revenues
If funds allocated for R&D are less than the amount needed for ongoing projects,
no new projects are begun. Up to a point, existing projects continue to receive
funding
When the number of new blockbusters increases, imitators increase their targeted
R&D to earnings ratio subject to constraints on R&D growth
If the retained earnings targeted for R&D drops below 50% of what is necessary to
fund ongoing projects, the firm stops all R&D activity
Policy Experiments
They perform several policy experiments; change patent life, for example,
and observe the effects on pioneering R&D, imitation, etc.
In these experiments, they assume the target R&D to sales ratios do not
change when the policy changes
The experiments incorporate parameter estimates for R&D costs, technical
and commercial success probabilities, sales revenue distributions,
and other parameters that match the pharmaceutical industry during
the 1970’s
The main policy variables analyzed are regulatory review times, patent
life, and the degree of sales loss to generics after patent expiration
Base Case Parameters and Modifications
Based on the 1970’s:
1. The average discovery phase is three years, development takes eight years
2. Only pioneering firms need discovery, so imitators have a longer effective
patent life (11 years compared to 8)
3. After patent expiration, 5% of the sales are lost to generics in the first year and
10% in all subsequent years of market life
They compare this to more modern times, where the average expected loss to
generics would be 50% after patent expiration
The impact depends critically on the patent life; with a short patent life, rapid
generic entry is particularly damaging to pioneering firms
The 1984 Act extended the patent life for pioneers; they also consider this effect,
looking at increases of three and six years
They also consider reductions in regulatory review times, which increase positive
cash flow earlier in the life cycle than patent extensions
Simulation Experiments
They assume the industry initially consists of twenty equal sized firms
Ten are pioneers; ten are imitators
In year 1, each firm is already a going concern and owns a portfolio of
drugs developed and marketed over the preceding 20 to 30 year period
It is also performing R&D for projects in various stages of the
development process
Each firm earns $57 million in the first period and spends 28% of this on
R&D. Given the projects in progress, there is an expected value of 6
pioneering products and 15 imitative ones each year
After 50 Years
After 50 years have elapsed (average results from 10 simulations),
industry net revenue has approximately doubled
The average market share of the pioneers is significantly larger than that
of the imitators (56% compared to 44%)
Imitators have more product introductions, but they have smaller average
sales than pioneers
Pioneers have higher R&D
The market share of the top four firms rises from 20% to 42%
Changes in Generic Competition
Consider moving from the base case of 10% sales loss after patent
expiration to 50%
The assumptions on effective patent life for pioneers and imitators, 8 and
11 years, are retained
The rate of innovation and other performance variables are highly
sensitive to this assumed increase in the degree of generic competition
Industry revenues and R&D are reduced by approximately 30% and new
product introductions by 20%
If generics hurt pioneers more than imitators (60% loss for pioneers, 40%
for imitators), then the revenues and R&D of pioneers fall more
relative to that of imitators
Changes in Effective Patent Life
The 1984 Act encouraged generic entry but also extended patent lives for
innovators
To consider this effect, they maintain the assumption of a 50% post-expiration
sales loss to generics
They assume that patent lives increase by three years for pioneers and imitators
As a result, industry R&D and net revenues increase by over 20% relative to the
case without patent extensions
Approximately 75% of the loss from enhanced generic competition is restored by
the three-year increase in patent life.
These benefits are subject to diminishing returns; a six year increase in patent life
has a very small marginal effect relative to the three year increase. This is
because the gains come late in the product’s life cycle when revenues are
already low
Changes in Regulatory Clearance Times
They consider reducing regulatory clearance times by one and two years
They find that innovation levels are very sensitive to this change
A one-year reduction increases revenues and R&D by approximately 30%
There is a slight tendency for pioneers to benefit more than imitators
There are diminishing returns in moving from one to two years, but these are not
as severe as in the case of patent extensions
The stimulative effects on innovation of a one-year reduction in regulatory
approval times is equivalent to a five or six year patent extension
If a firm is able to increase its cash flow early in the life cycle, it is able to initiate
new projects sooner, realize returns on them sooner, start more new projects,
etc. The cumulative effect is substantial
Even if reductions in regulatory times are accompanied by equal reductions in
patent life, there is still a substantial positive effect (regulation has no benefit
in this model; it is a pure cost)
Robustness
They consider the sensitivity of their results to changes in the number of
firms participating in the industry, the extent to which new product
sales are market expanding vs. redistributive, and the richness of
technological opportunities
Reducing the number of firms had no effect
If business stealing rises then revenues and product introductions fall (this
could be endogenized. If more products are introduced then business
stealing would rise – they are competing in similar markets)
Improving technological opportunities raises revenues and innovation
They do not allow for entry into the industry