chapter 14: the pharmaceutical industry health economics
TRANSCRIPT
Chapter 14: The Pharmaceutical Chapter 14: The Pharmaceutical IndustryIndustry
Health EconomicsHealth Economics
OutlineOutline
Competitiveness of the pharmaceutical industry
Conduct
Performance
Benefits of DrugsBenefits of Drugs
Reduce mortality.
Reduce morbidity/improve quality of life.
Reduce cost of treating diseases.
Industry StructureIndustry Structure
# and size distribution of sellers. Buyers’ side characteristics. Barriers to entry. Government regulation.
Fortune Magazine, 2001
Leading Pharmaceutical Companies, 2000
Company Sales $bMerck 40.3Johnson & Johnson 29.1Pfizer 29.6Bristol-Myers Squibb 21.3Pharmacia 18.1Abbott Laboratories 13.7American Home Products 13.8Eli Lilly 10.9Schering-Plough 9.8Amgen 3.6
Drug Sales $mPrilosec $2,933Prozac $2,181Lipitor $1,544Zocor $1,481Epogen $1,455Zoloft $1,392Prevacid $1,245Paxil $1,190Claritin $1,150Vasotec $1,086
Best-Selling Drugs, 1998
Industry 4-firm CR %Apparel 9.4Basic chemicals 13.9Computer software 28.2Food & non-alcoholic beverages 13.9Footwear 22.6Furniture manufacturing 24.7Passenger cars 70.5Pharmaceuticals 43.3
4-Firm Concentration Ratios 1997
Can competition be accurate Can competition be accurate measured at the industry level?measured at the industry level?
Most drugs are not substitutes to the patient.
The relevant product market is the therapeutic market. Only a few major drugs compete in most
therapeutic markets.Concentration ratios at this level are higher
than for industry as a whole.
Therapeutic Market Four-Firm RatioAntidepressants 68Antihistamines 90Antihyperlipdemics 74Antihypertensives 49Anti-Rheumatics/NSAIDs 55Antivirals 18Caphalosporins 79Gastrointestinal Diseases 62Nasal Corticosteroids 72
Concentration Ratios for Therapeutic Markets, 1997
Express Scripts Drug Trend Report, 1997
Firms tend to make most profits from 1 Firms tend to make most profits from 1 or a few key drugs.or a few key drugs.
Company PercentageGlaxo Inc. 75Pfizer 60Upjohn 58Eli Lilly 56SmithKline Beecham 53Merck & Co. 52Marion Merrell Dow 50American Home Products 32Johnson & Johnson 30Bristol-Myers Squibb 28
Top 3 Drugs as a % of total Prescription Sales, 1992
BCG, The Changing Environment for U.S. Pharmaceuticals, 1993
The Buyer SideThe Buyer Side
Expend. Source ($billions) PercentTotal 99.6 100.0%All private 77.9 78.2Out-of-pocket 34.9 35Private insurance 43 43.2
All government 21.7 21.8Federal 12.4 12.4State 9.2 9.2
Buyers of Prescription Drugs, 1999
www.phrma.org
How 3rd parties influence drug demandHow 3rd parties influence drug demand
Even if consumers exert little influence over drug choice, 3rd parties are making the market more competitive.
Formularies - list of selected drugs physicians may prescribe.
Used by hospitals to limit inventories and costs.
Used by most HMOs and many PPOs. Used by many state Medicaid programs.
Drug utilization review Used by insurers to enforce formularies,
identify inappropriate prescribing practices.
Government influence 1990 Omnibus Budget Reconciliation Act -
Federal funding provided for drug only if state Medicaid program receives manufacturer rebate agreement
Government influence (cont.) 1992 Veterans Health Care Act - price
discounts for Federal Supply Schedule, VA, Dept. of Defense.
These programs may restrict costs for government, but drug firms may be forced to raise nonfederal prices.
“…managed care emphasizes less-expensive, preventive types of treatment.”
“The rate of growth for drugs to treat high blood pressure and high cholesterol in certain managed-care strongholds on the West Cost has gone off the charts.”WSJ 10/17/96
“Consumers in the $94 billion prescription drug market are mostly indifferent to price. What will happen when they all become budget conscious?
Forbes 4/5/99
Pharmacy Benefit ManagersPharmacy Benefit ManagersGeneral StrengthsGeneral Strengths
Information - e.g. Medco’s 60m patients.How drugs prescribed, used, impact on
disease.Can prevent inappropriate drug interactions,
under/over medication PBMs provide drugs at lower costs.
Achieve econ. of scale in pharmacy benefits by serving multiple plan sponsors.
Large market share on buyer’s side stronger negotiating power w/ drug companies.
Vertical IntegrationVertical Integration
Brand name drug companies are purchasing PBMs.
EstimatedDate Acquirer Target Exp. ($m)Nov-93 Merck Medco $6,600May-94 SmithKline Beecham Diversified $4,000Jul-94 Eli Lilly PCS Health $2,925
Vertical IntegrationVertical Integration
Good or bad idea?Buy the information, not the PBM
“Industry consultants and Medco competitors argue that Merck could have bought that information from Medco or others in the field without buying the company.” NYT 8/5/93
Critics argue that PBMs will only serve to lower prescription pharmaceutical prices.
Vertical IntegrationVertical Integration
Comments from Roy Vagelos, former Merck CEO “In classic terms of competition, we could see
that the power of the buyers was growing…PBMs were…bringing together the person who chooses the drug and the person who pays for the drug.”
“Having salespeople visit doctors’ offices does not allow us to reach PBMs, HMOs, or plan sponsors -- the major players in the emerging market.”
Vertical IntegrationVertical Integration
Merck bought Medco as a response to managed care. Strategic attempt to market power. How?
Followup on patients w/ chronic illness who may stop taking prescribed meds.
Position Merck drugs favorably on formulary. e.g. lower patient copay, or lower cost to plan
sponsor.
Vertical IntegrationVertical Integration
Offer risk sharing to demand. e.g. refund Proscar if no effect on BPH after 1
year. Offer disease management.
Improves patient health, gives company more influence in tx process.
Vertical IntegrationVertical Integration
PBM purchase will also affect Merck’s product development.“Consider what happens if instead of having 20
products on the formulary we have 40.” more incentive to develop generics.
Impact of PBMs on drug prices:Price competition is inevitable.“Merck will have to grow through increased
volumes without considerable price increases. That seems obvious now, but it wasn’t six or seven years ago.”
Barriers to entryBarriers to entry
Government patents.
Brand loyalty advantage.
Control over a key input.
Government PatentsGovernment Patents
Innovating firm gains the right to be sole producer of a drug for legal maximum of 20 years. Preserves incentives for firms to undertake
risky and costly research and development (R&D) that is socially valuable.
Rationale: Monopoly restriction of output better than having no output at all.
Monopoly power of patents is not Monopoly power of patents is not always strong.always strong.
Patents granted for chemical composition, not therapeutic novelty.
Tagamet & Zantac both were patented, competing in antiulcer market.
Significant part of patent life may be spent trying to get FDA approval. “effective” patent life = 8 years.
Monopoly power of patents is not Monopoly power of patents is not always strong.always strong.
1984 Waxman-Hatch Act - benefits for both brand-name and generic companies. Effective life of new drug patent can be
extended up to 5 years of FDA delayed market introduction.
Fast approval process for generics: eliminated proof of safety & effectiveness.
Pharmaceutical Industry ConductPharmaceutical 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 BehaviorPricing Behavior
Can the brand-name firm maintain its price once its patent expires and generics enter? Average price differential between brand-name
and generic firms = 127%, but brand name market share = 63.4%. (Hurwitz & Caves, 1988)
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 pre-entry price.
Pricing BehaviorPricing Behavior
Brand-name firms segment the market. Remaining customers relatively price
insensitive. Inelastic demand curve allows them to
maintain price.
Express Scripts Drug Trend Report, 1998
Promotion StrategiesPromotion Strategies Promotion Magnitude:
Research-base 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.
Product InnovationProduct Innovation
Product InnovationProduct Innovation
Product InnovationProduct Innovation
Www.phrma.org
Product InnovationProduct 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.
Year Drug Use 1998 sales $m1985 Protropin/ Growth hormone for 214
Nutropin for short stature1987 Activase Blood-clot buster 2131994 Pulmozyme Cyctic fibrosis 93.81997 (Dec.)Rituxan Low-grade NH 162.6
lymphoma1998 Herceptin Breast Cancer 30.5
Genentech's Big Sellers
Drug UseSingulair AsthmaMaxalt MigrainesAggrastat Acute Coronary SyndromePropecia Male Pattern Hair LossCosopt Glaucoma
Merck's New Products, 1998
Roy Vagelos’ Views on R&DRoy Vagelos’ Views on R&D Priority areas are those where:
No therapies or drugs are available.Science must be advanced enough to make
a breakthrough.Must have enough knowledge of the
disease to have an idea how to arrest it. Rational drug discovery - create specific
molecules to attack specific molecular drugs. Enzyme inhibition, which was successful in
Merck drugs treating high cholesterol, high blood pressure, and prostate disease.
Pharmaceutical Industry PerformancePharmaceutical Industry Performance
Year All Items Prescription Drugs1970-79 7.1 3.61980-89 5.6 9.61990-94 3.6 6.91995 2.8 1.91996 3 3.41997 2.3 2.61998 1.6 3.7
Urban Consumer Price Inflation Rates
Does the absence of perfect competition higher prices & restricted output?
Cautionary note on inflationCautionary note on inflation The inflation rate calculated by BLS is
based on a price index, which may overstate the true in drug costs.
Price indexthe relative cost of purchasing a fixed
“basket” of drugs in year t, vs. the costs of same basket in a base period.
drugsNixp
xpN
i ioio
io
N
i it ,....11
1
Price Indext =
Cautionary note on inflationCautionary 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.
1997 ProfitsRank Company as % of Assets
4 Schering-Plough 22.26 Bristol-Myers Squibb 21.410 Merck 17.912 Abbott Laboratories 17.419 Johnson & Johnson 15.422 Pfizer 14.4
500 Median 3.9
Companies in the Fortune 500Return on Assets for Pharmaceutical
Are profits in the drug industry “too high?”
Are profits in the drug industry too high?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.