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This case study is a recent history of the pharmaceutical industry based on all ofPorter's five forces. If you would like to try this assessment on your own business thentry out our Porter's 5 Forces Assessment

In the 1970s and 1980s, the average profit margin (as a percentage of revenues) ofthe Fortune 500 pharmaceutical companies was two times greater than the medianfor all industries in the Fortune 500 Each dru introduced between !"#! and !"#$%made at least &$ million more for its investors( after ta)es( than was needed to payoff the costs to develop it . . . *uch profitability was two to three percenta e points

reater than for comparable industries( even after factorin in the risks of new drudevelopment+. ,early two decades later( in !"""( the industry was still a star. Thepharmaceutical industry ranked at the top in all three of Fortune ma a-ine+s measuresof profitability return on sales( return on assets and return on e/uity. 0hat made the

lobal pharmaceutical industry so profitable for so lon 1 0hy has its profitabilityremained so stron ( and will the industry remain so attractive1

Threat of entryFor an entrepreneur( hi h barriers to entry make it more difficult to launch a venture.2ut happily( for those who are somehow able to enter( these same barriers serve toprotect their ventures once they have 3oined the party. Thus( while barriers to entrycan be considered obstacles for the entrepreneur( they also serve to keep competitorsout of the industry. A number of barriers mute the threat of entry into thepharmaceutical industry. These include barriers both financial and intan ible innature( ran in from hi h fi)ed costs to strin ent intellectual property protection.4et+s look in some detail at conditions in the pharmaceutical industry in the !"# s.

6eavy e)penditure on research and development were 7and still are8 re/uired for thearduous processes of dru discovery( development( manufacturin ( and approvalthrou h the various re ulatory bodies( such as the Food and 9ru Administration 7F9A8in the :*A and the ;ommittee on *afety of

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patents for their new dru s. These patents were issued on either the dru +s chemicalstructure or its method of manufacturin or synthesis. This hi hly favourablecompetitive environment( in which dru companies obtained patents to protect themfrom rivals( meant that competitors were effectively blocked from manufacturin andmarketin dru s with the same chemical composition for !B years( which e/uates tobetween ei ht and !? years once the dru actually ets to market.

The result1 In terms of threat of entry( the picture of the pharmaceutical industry inthe !"# s was clear. Entry barriers were e)tremely hi h( resultin in little threat ofentry( a very favourable condition for industry incumbents and for new pharmaceuticalstartups that could find a way to enter.

*upplier power

Pharmaceutical companies were flooded with raw material suppliers an)ious to sell tosuch a stron and profitable industry. In !"#?( there were over !?( chemicalcompanies in the :*A alone. Their products had lon shelf lives( were readily availablefrom numerous sources( and were bou ht lar ely on the basis of price and delivery.These conditions left the chemical suppliers with little power to set the terms andconditions under which their raw chemicals were sold to the dru companies. From thedru companies+ point of view( supplier power was virtually none)istent.

2uyer power

6ow would you like to be in an industry where your buyers are uninformed about yourproduct and almost ! per cent insensitive to its price1 ,ot only that( but ima ine

that there are few if any substitutes for your product( and that usin it may be amatter of life or death for your consumer. These were( for the most part( thecircumstances prevailin in the pharmaceutical industry throu h the !"# s. Theindustry en3oyed an almost powerless roup of buyers. 9ru companies reaped thebenefits of unaware doctors who were partial to prescribin brand>name dru s toobtain the most medically effective solution( re ardless of priceC price>insensitivepatients who did not care about the cost of their prescription medicationsC illinformedconsumers who blindly trusted their doctors+ treatment su estionsC and fewalternatives to prescription dru s. The weakness in buyer power contributedsi nificantly to the profitability of the pharmaceutical companies.

These companies also benefited from consumer trends in Europe and ,orth America

towards health and nutrition. ;onsumers were increasin ly ea er to do whatever ittook to become or stay healthy. Further( consumers had the lu)ury of bein indifferentto dru prices because most of them did not pay full price for their medications.

ather( throu h the !"# s in most developed countries( overnment a encies(insurance companies or employers paid the patient+s prescription dru bill. Andwithout easy access to information on medications( customers had little say in theirtreatment plans.

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Threat of substitutes

:ntil the mid>!"# s( the lobal pharmaceutical industry was lar ely unthreatened bysubstitute products. If a patient was ill( they took the medicine the doctor ordered.Patent laws prohibited companies from replicatin others+ brand>name dru s for aslon as !B years( and other re ulations deterred the development of chemicallye/uivalent eneric dru s. For most conditions treatable by prescription dru s( theresimply were no substitutes for the medications the doctor prescribed.

;ompetitive rivalry

The pharmaceutical industry of the !"# s was populated by hundreds of companies(thou h none had more than 5 per cent market share. There were two main reasons thepharmaceutical industry was so fra mented

9ifferent companies focused on entirely different classes of dru s. These classesincluded cardiovascular treatments( antibiotics( central nervous system therapy(astrointestinal treatments( etc.

The industry+s rowth rate made it easy for competitors to row without takin sharefrom each other. There was little pressure to e)pand beyond one+s niche( ivenabundant opportunities for rowth therein.

The result of this fra mentation was that most firms had few direct competitors. Thelack of direct competition allowed dru companies to raise prices as they pleased.;ouple this lack of competition with a weak threat from substitutes and little buyerpower( and the industry e)perienced little dissent when raisin prices to meet profit

ob3ectives. ;ompetitive rivalry was almost none)istent.

*ummary of industry attractiveness

The result of these industry conditions was impressive profit rowth throu h themiddle of the !"# s. 0ith si nificant barriers to entry( docile suppliers( powerlessbuyers( almost no threat of substitutes( and little rivalry( the pharmaceutical industryin the !"# s was 3ust about as perfect an industry as one could ima ine. Diven itsattractiveness( the industry attracted the attention of enetic and molecular biolo yscientists and the venture capital community( who saw its appeal and thou ht their

revolutionary approaches to dru therapy could attract enou h money to overcome theformidable entry barriers the industry en3oyed.

Thus( as scientific advances in biotechnolo y took hold( numerous entrepreneurialcompanies like Denentech and Am en were founded to commerciali-e new scientificbreakthrou hs. Denentech( the first biotech firm havin commercial success(developed a protein that broke up blood clots. Am en+s famous molecular biolo y usedrecombinant 9,A to produce erythropoietin( a hormone that increases the supply ofred blood cells in anaemic patients under treatment for cancer and other diseases. 2y

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? ( erythropoietin was eneratin &? billion in sales and another &$ billion inlicensin revenue for Am en. 2oth of these new entrants fared very well in thisattractive industry

Denentech went public in !"# ( and by ? ! its shares had appreciated ?B per centsince its IP .

Am en shares( first offered in !"#$( soared more than ! ( per cent.

0as the pharmaceutical industry an attractive industry in which to play1 The venturecapitalists that backed Denentech( Am en and other companies like them have notbeen disappointed. The scientists>turned>entrepreneurs whose technolo ies werebacked have prospered as well. Thus( for entrepreneurs who can marshal theresources to overcome hi h barriers to entry and who have somethin to sell thatcustomers want attractive industries like pharmaceuticals can be rewardin places toplay( indeed.

The pharmaceutical industry at the turn of the twenty>first century

Alas for the dru makers( industries are not static places. 4ike the rest of the businessworld( industries are dynamic( sub3ect to ever>chan in environments. Thepharmaceutical industry has not remained /uite as cushy as it once was. 4et+s look atwhat has chan ed.

Threat of entry

*tartin in the mid>!"# s( the barriers to enter the pharmaceutical industry be an toshow cracks. ,ew le islation made it easier for eneric dru companies to enter themarket. In the :*A( the !"#@ 0a)man>6atch Act( which chan ed the rules for enericdru manufacturers( reduced the barriers to eneric entry. Instead of havin to provethe eneric dru +s safety and efficacy( the act re/uired companies only to prove theirformulas were e/uivalent to that of the brandname dru . The subse/uent rowth in

eneric dru s was profound. 2y !"" ( eneric dru s accounted for more than @ percent of pharmaceutical prescriptions.

Aside from the influ) of enerics( the pharmaceutical companies also saw a wave ofbiotechnolo y competitors enter their industry Denentech( Am en and many others su estin that economies of scale meant less than they used to( and that barriers toentry( while still hi h in absolute terms( were droppin ( thanks in part to theavailability of venture capital. Further( the biotech companies+ new science>focusedresearch model( known as rational dru desi n( stood the traditional approach to drudiscovery on its head. These dru companies worked backwards from known diseasebiochemistry to identify or desi n chemical %keys+ to fit the biochemical %locks+ of thatdisease.

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The result of these chan es1 2arriers to entry crept lower( increasin the threat ofentry and makin the industry somewhat less attractive.

2uyer power

2e innin in the mid>!"# s( three developments radually be an to increase the powerof the pharmaceutical industry+s buyers

The rowin stren th of mana ed care in the :*A( the industry+s lar est market.

Increased pressure from overnments( especially in Europe.

A better>informed patient population.

The American transition from an insurance>based healthcare system to one ofmana ed care chan ed the dynamics of the pharmaceutical industry dramatically. 2y!""$( # per cent of the :* population was covered by mana ed care or ani-ations7

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,ot only was direct competition from eneric dru s impactin the industry( but trendstoward more natural therapies led consumers to try substitutes for prescription dru s.E)ercise( nutrition and herbal remedies all be an to take market share from theprescription dru makers.

;ompetitive rivalry

Throu hout the late !"# s and the early !"" s( rivalry in the pharmaceutical industryincreased. Diven the new pressures described above( traditional dru companies feltthe pressure to consolidate to take advanta e of economies of scale. 2y choosin tomer e( rivalry amon the top firms increased( as their areas of e)pertise be an tooverlap.

Additional rivalry stemmed from the flood of more science>focused dru discoveryfirms. 0hile some biotechs were purchased by the lar e dru companies( othersbecame stron competitors in their own ri ht. :nlike the dru companies( biotechswere not burdened with hi h overheads( and they possessed superior product anddisease knowled e in their chosen se ments. ational dru desi n enabled them todiscover new therapeutic compounds more /uickly and more efficiently than before.0hile traditionally these biotechs had discovered new dru s and then sold theirdiscoveries to established dru companies( this pattern seemed to be chan in ( assome be an not only to discover but also to develop and market their own dru s. Thus(the pharmaceutical industry found itself with a whole new set of competitors( some ofwhich had lower cost structures and were more a ile and science>focused.;ompetitive rivalry had increased.

*ummary of industry attractiveness enterin thetwentyfirst century

6ow has the industry fared in li ht of these developments1 A study by the :*;on ressional 2ud et ffice concluded that( %since !"#@( the e)pected returns frommarketin a new dru have declined by about !? per cent( or &?B million in !""dollars. That decline has probably not made dru development unprofitable onavera e( but it may have made some specific pro3ects unprofitable+.

In spite of its decline in attractiveness( in ? the pharmaceutical industry stillranked as the most profitable industry in the :*A

eturn on assets was !B.B per cent.

The top !! :* pharmaceutical companies enerated almost &? billion in revenuesthat year and profits of &?# billion.

0hile not /uite as attractive a place to compete as it had been in the !"# s( thepharmaceutical industry remained far more attractive than most. 0hy1

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Threat of entry remained comparatively low( despite the incursion of eneric drumakers and biotech firms. *tartin a pharmaceutical company isn+t nearly so simpleas( say( startin a restaurant.

2uyer power had increased a enuine problem.

2ut suppliers to the pharmaceutical industry still lacked power.

*ubstitutes such as e)ercise( nutrition and herbal medicines were no match forprescription therapies for cancer and other life>threatenin illnesses.

;ompetitive rivalry remained modest( as the dru companies( havin commoninterests( sou ht to protect their traditionally hi h profit mar ins.

Thus( the pharmaceutical industry remained an attractive place to play( far more sothan most industries( includin the di ital subscriber line industry( which we e)aminene)t. 0ill this continue to be the case( or will the pressure of these trends erode theindustry+s attractiveness further1 nly time will tell.

4essons learned from the pharmaceutical industry

As the pharmaceutical industry e)ample shows( re ulatory issues can have powerfuleffects on industry attractiveness and the profitability of the firms that comprise it.0here re ulation makes it difficult for competitors to enter and compete( and otherforces are also favourable( it+s worth an entrepreneur+s trouble to find a way in( asthe biotech companies have done. 2oth the lon >established players and the biotechnewcomers have prospered.

The pharmaceutical industry e)ample also shows that hi h barriers to entry are ood.4ove and cherish them. And( once you et in( work to keep the barriers hi h. Thesame is true of weak buyer and supplier power( and of little threat of substitutes( aswe+ve seen here. Even si nificant chan es in some of these forces were insufficient todetract si nificantly from the dru industry+s overall performance.

Finally( entrepreneurs should note that industry performance data( like those cited inthis chapter for pharmaceutical industry performance( are readily available in businesslibraries in most developed economies. It+s well worth a look at such data in the earlysta es of assessin an opportunity. If an industry is a poor performer overall( youshould take a critical look at your opportunity to ask why it should fare differently.0ithout a persuasively positive answer to this /uestion( I would su est movin on tosomethin more attractive.