The Market for High-Quality Medicine:
Retail Chain Entry and Drug Quality in India
Dan Bennett, University of Chicago
Wesley Yin, UCLA and NBER
RAND Corporation
May 18, 2015
Motivation
Heterogeneous and uncertain drug quality
• Counterfeits and substandard drugs pervasive in dev. countries
• Small producers manufacture generic drugs with little oversight
Health and economic impacts
• Inadequate treatment, toxicities, drug resistance
• Effective medicine and human capital accumulation, labor supply,
earnings (Miguel and Kremer 2004, Baird et al. 2012).
Motivation
Link between growth and provision of drug quality
• How does income growth translate to provision of quality?
Role of income growth
• Normal good, consumers demand higher-quality medicine
• Production of high quality medicine exhibits scale economies;
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growth pays for organizational changes
Allows for stronger legal institutions/tort law enforcement, fosters
higher product quality (Spence 1977, Landes and Posner 1987)
How do private markets improve quality in the face of imperfect
information and weak regulation?
This Study
Chain store pharmacy forms, enters Indian retail market
• (High quality) chain’s formation is a response to increased demand
• It’s entry punctuates equilibria in local markets
Demand growth and organizational change
• Quality improvements driven by technological and organizational
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changes (new systems of distribution, vertical integration, large
investments in QC , etc.)
As demand markets grow, larger firms can exploit scale economies.
Firms that can produce higher quality have incentives to jointly produce
and signal quality (Milgrom & Roberts 1986)
Chains may have stronger incentive to invest in and signal quality
(Akerlof 1970; Jin & Leslie 2009)
Effects on incumbents is ambiguous
• Competition on price/quality vs. market segmentation
Study Design
Natural experiment design
• MedPlus is a new pharmacy chain with integrated distribution,
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contract manufacturing, ostensibly high quality, lower prices
In 2010, chain execs identified 18 candidate markets in
Hyderabad to enter
Appropriate retail space opened up in 7 of 18 candidate markets
Plausibly exogeneous entry
Survey all markets (+2) before/after entry (5 stores per market)
Data collection: “secret shopper" pharmacy audit, consumer
survey, pharmacy survey, customer traffic enumeration
Summary of Findings
Main results
• Incumbents lose customers, some exit the market.
• Quality at incumbents improves; prices fall (especially for non-national
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brands)
Both high-SES and low-SES consumers/markets benefit
Consumers imperfectly perceive quality improvements
Incumbents match the chain's quality but not its prices, revealing
productivity differences
Mechanisms
• Retail competition with price and quality elastic consumers
• Chain entry raises awareness of quality, shifts preferences
• Reject wholesale market spillovers, whereby chain entry reduces
stocking of low quality drugs among wholesalers
Outline
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Background
Study design and empirical strategy
Main results on price and quality
Interpretation
Background on Indian drug market
Manufacturers
• 250 “national" manufacturers and around 8000 small “local"
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manufacturers
Limited regulatory oversight, particularly for local manufacturers
The supply chain
• Mom-and-pop pharmacies buy from a complicated supply chain
Retailers
• Market power
• Have more discretion over price/quality for non-national brands
• Through longstanding relationships with wholesalers, retailers appear
to develop perceptions of quality
Retail Pharmacies in Hyderabad
Incumbents
• Small single-enterprise “mom and pop" pharmacies compete locally on
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price and quality.
Study markets have a median of 24 pharmacies/km2
The median pharmacy occupies 350 square feet of space.
13% of incumbents have air conditioning and 15% have a door.
Chain pharmacies
• Three chains operate in Hyderabad: MedPlus, Apollo, and Hetero.
• MedPlus founded in 2008 and operates around 250 stores in
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Hyderabad.
MedPlus pharmacies are enclosed and air conditioned
MedPlus contracts with manufacturers to produce/sell in-house brand
MedPlus bypasses wholesale market; buys direct from national brands
Got amoxicillin?
Background on drug quality
Determinants of drug quality
• Quality control during the manufacturing process.
• Proper handling and storage during distribution and while on shelf.
• Procuring ingredients is not a major quality constraint
Indian Pharmacopeia standard
• Active ingredient concentration, uniformity, and dissolution.
• A sample is substandard if it fails in any dimension.
• In our data, most substandard samples fail the active ingredient
requirement.
Surveyed drugs
• Ciprofloxacin and amoxicillin are two important, widely-used antibiotics
• The effectiveness of antibiotics is difficult to infer
Outline
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Background
Study design and empirical strategy
Main results on price and quality
Interpretation
Study Design
Logistics
• In 2010, the chain identified 18 candidate entry markets
• We added 2 slightly lower income markets
• Based on our pharmacy census, we enrolled 5 pharmacies per
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market (n = 100) in the study.
After a baseline survey, the chain actually entered 7 markets.
Natural experiment
• MedPlus entered markets where it could obtain suitable space.
• Suitable retail space opening plausible exogenous
• Contextual, statistics evidence support validity of study design
Data Collection
Components
• Pharmacy census (n = 401).
• Mystery shopper audit with quality testing: samples of
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ciprofloxacin and amoxicillin collected by high-SES and low-SES
auditors (n = 800)
Consumer survey with shoppers and non-shoppers (n = 5234)
Pharmacy survey and customer traffic enumeration (n = 107)
Timing
• Round 1: May-July 2010
• Round 2: May-July 2011
• Round 3: May-July 2012 (census, traffic, consumer)
Comparing Chain to Incumbents
Empirical Strategy
Model
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Audit scenario s, pharmacy i, market m, time t
Market fixed effects
Time varying market demographic and health characteristics
Cameron, Gelbach, and Miller (2008) bootstrapped SE’s
Identification
• Factors that determine entry are uncorrelated with unobserved time•
varying factors that affect the outcome (e.g. demand growth)
Exogeneity supported by contextual, statistical evidence, and tests for
unobserved selection
Identification
Candidate markets limited to middle income markets
• 250 stores in Hyderabad, relatively wealthier areas
• Final expansion to a few middle income markets; did not consider
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slightly less affluent neighborhoods
18 markets chosen on basis of income; relatively more homogenous,
limiting potential for selection into treatment on unobserved SES
Entry depending on vagaries of thin real estate market
• The chain had very specific space requirements and a short window for
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final expansion in Hyderabad
1000-1200 ft2 on ground level facing busy commercial street
Spaces too small are large turned down
No differential trends
Ex-post validation
Effect sizes large relative to variation in key SES variables
• Market average income would need to more than double in treatment
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markets to generate treatment effects
Education levels would need to increase by 5 years (50%)
Bounds on selection on unobservables
• Follow Oster (2014) and Altonji et al. (2005) to bound extent of
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unobservable selection needed to generate effects spuriously
Under assumption of proportional selection, unobserved selection would
have to be implausibly large
Chains have subsequently entered 9 control markets.
Outline
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Background
Study design and empirical strategy
Main results on price and quality
Interpretation
Secular quality trend
Climate
• Humidity and temperature are key determinants of quality,
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especially for these antibiotics.
Water molecules necessary for molecular breakdown; heat
increases the rate of chemical reaction
Peak relative humidity was 8.7 points higher in Round 2 than in
Round 1.
The share of audit days with both high temperature and humidity
rose from 54 percent in Round 1 to 97 percent in Round 2
Impact on Quality
Impact on Quality
Impact on Prices
Robustness checks
Outline
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Background
Study design and empirical strategy
Main results on price and quality
Interpretation
Effects not due to spillovers
Consumer preferences
The Market-wide Impact
Motivation
• Both chain entry and the incumbent response matter for consumer
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welfare.
The benefit of chain entry may vary across consumers
Socioeconomic heterogeneity
• Across pharmacies: interact with average customer education.
• Within pharmacies: interact with mystery shopper SES.
Modifications to the previous approach
• Include observations from the chain in the regressions (+7 pharmacies).
• Weight the regressions by the customer traffic
Productivity of the Chain
Market-wide impact
Is Quality Observable
Consumer Information
• Competition only leads to higher quality if quality is observable.
• Quality may be indirectly observable through advertising, reputation,
and word of mouth.
Actual and Perceived Quality
• The impact of chain entry on perceived quality.
Methodology
• Our consumer survey elicits perceived quality on a scale of 1-4.
• The perceptions of non-shoppers are easier to interpret because of
selection into the shopper sample.
Consumer perceptions
Conclusion
Implications
• Chain entry has positive quality externality for non-chain consumers.
• Consumers appear to infer quality through imperfect market signals
• Productive organizational technologies (e.g. chains) with scale
economies and their competitive effects
» On quality and prices of incumbents
» Driving out less productive firms
» Joint mechanism translating income growth to higher quality
• Perhaps long run, single-enterprise shops exit, market will rely on
competition among chains
Policy
• In settings without an effective quality regulator, policymakers may
improve drug quality by encouraging chain retailers