The pharmaceutical industry in the United States is one of the most publicly discussed and one
of the least understood industries in the economy. The prescription pharmaceutical market has
several unique traits. Products have to be ordered by physicians, not by the person who
consumes them. The party paying for the prescription may be the patient, but more often
today it is a Pharmaceutical Benefits Management (PBM) firm. PBMs work with managed care
organizations to try to acquire drugs at lower cost through the use of formularies. A drug
formulary is a list of prescription medications for which a drug plan will reimburse. Formularies
are drawn up by listing preferred drugs to be used for any given malady. This is possible
because many drugs are extremely similar to other drugs in both their effectiveness and their
likelihood to cause side effects. Thus, these products should be competing against one another
largely on price. But, of course, patients cannot go into a drug store and choose one drug over
another based on price; they have to take the product the doctor prescribed. The PBMs try to
create this missing price competition by telling pharmaceutical firms that if they provide the
PBM’s manage care partners with a lower price, the PBM will pressure doctors to write
prescriptions for the firm’s product. The PBMs also incent the patient to use the formulary drug
by charging a lower co-payment if these “preferred” products are used.
Developing new drugs is a major undertaking, particularly for drugs that are truly
unique. Although the Food and Drug Administration tries to “fast track” important new drugs
through the approval process, the time between identifying a molecule that could be
considered a valid “drug target” and the approval of a new drug may be seven to ten years or
longer. By that time, a firm may have invested upwards of $400 million to develop the drug. Of
drugs approved, most will not earn that amount back in gross revenues. In addition, the
majority of drug targets never make it to market, leaving it to the few successful drugs to cover
their costs as well. These research expenses are the main cost in a drug, as the product itself is
often mass produced in bulk with basic chemical inputs.
One reason people are so interested in the pharmaceutical industry is that it directly affects
their health and that of their loved ones. Most illnesses that pharmaceuticals treat effectively
today were not treated effectively just a century ago by any medical product or procedure. As a
result, drugs have taken on an almost mystic quality for many consumers who look to their pills
and potions as the key to retaining or sustaining good health.
Questions: Using the information provided about the pharmaceutical industry, systematically
examine the industry using the five forces model. What is your assessment of the industry
profitability based on the five forces analyses?