Lecture Health economics - Chapter 12: The pharmaceutical industry (Part 2)

Lecture Health economics - Chapter 12: The pharmaceutical industry (Part 2). This chapter presents the following content: Pharmaceutical industry conduct, pricing behavior, promotion strategies, Are DTC ads reaching consumers? Ads are read and acted upon, misconceptions abound,...

The Pharmaceutical Industry Part Professor Vivian Ho Health Economics Fall 2009 Pharmaceutical 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 Behavior Can the brand-name firm maintain its price once its patent expires and generics enter?  After patent expiration, each 10% increase in the price differential for brand-name drugs relative to generics resulted in only a 5% drop in market share for the brand-name drug (Hurwitz & Caves, 1988)  Average price differential between brand-name and generic firms = 127%, but brand name market share = 63.4% Pricing Behavior The longer the brand-name drug’s effective patent length, the more market share it preserved after patent expiration The arrival of an additional supplier was estimated to reduce the brand-name drug’s market share by 1.25 percentage points Pricing Behavior Branded drugs’ prices 11% years after generic entry (Grabowski & Vernon 1992)  Yet brand-name drugs lost 1/2 of market share Average market price fell to 79% of preentry price Pricing Behavior Brand-name firms segment the market Remaining customers relatively price insensitive Inelastic demand curve allows them to maintain price These studies suggest that generic drug prices are substantially lower than brand-name prices Express Scripts 2007 Drug Trend Report Promotion Strategies Promotion Magnitude:  Research-based 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 Direct-to-Consumer Prescription Drug Advertising: Bane or Boon? Richard L Kravitz, MD, MSPH UC Davis Center for Health Services Research in Primary Care A brief regulatory history 1981: industry shows interest in advertising directly to consumers 1983–1985: FDA obtains voluntary moratorium on DTC advertising  1985: moratorium lifted 1990: DTC advertising begins in earnest 1997: TV advertising made feasible through FDA policy change Patient requests and physician prescribing Patients requested prescriptions in 12% of visits (MD report) 42% of requests were for advertised products 74% of those requesting drugs received them (similar for advertised and non-advertised drugs) Patients requesting a prescription much more likely to receive one (AOR 8.7, 95% CI 5.414.2) Provoking clinical ambivalence “If you were treating another similar patient with the same condition, would you prescribe this drug?” Percent “possibly” or “unlikely”  Rx not requested: 13%  Any drug requested: 49%  Advertised drug requested: 70% Summary of Katz Studies DTC ads are reaching consumers Education is a side effect of promotion DTCA-induced requests influence prescribing A true reckoning of public health benefits and harms has not occurred Product Innovation Product Innovation Product Innovation www.phrma.org Product 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 go to Phase  36% of NCEs in Phase go to Phase Capitalized Cost per Approved Drug R&D costs are capitalized to the date of marketing approval The cost-of-capital is based on a CAPM analysis of the pharmaceutical industry An 11% real cost-of-capital was utilized for the period under study Millions of 2000 $ Out-of-Pocket and Capitalized Costs per Approved Drug 900 800 700 600 500 400 300 200 100 802 466 336 403 282 121 Pre-Clinical Clinical Out-of-Pocket Total Capitalized J DiMasi, R Hansen, and H Grabowski, “The Price of Innovation: New Estimates of Drug Development Costs”, Jan 2002 Pharmaceutical Industry Performance Does the absence of perfect competition higher prices & restricted output? Urban Consumer Price Inflation Rates Year All Items Prescription Drugs* 1970-79 7.1 3.6 1980-89 5.6 9.6 1990-94 3.6 6.9 1995 2.8 1.9 2000 3.4 4.4 2003 2.3 3.1 2005 3.4 3.5 2007 2.8 1.4 2008 3.8 2.5 *2000 - 2005 includes prescription drugs and medical supplies DRUG SPENDING INCREASED 5.4% from 2004 to 2005 6.00% 5.00% 4.00% 3.00% 5.4% Price Inflation 4.1% 2.3% 2.00% Utilization & Mix TOTAL 1.00% 0.00% -1.00% -2.00% IMS Health New Drugs -1.1% 2004-2005 Cautionary note on inflation The inflation rate calculated by BLS is based on a price index, which may overstate the true in drug costs Price index  the relative cost of purchasing a fixed “basket” of drugs in year t, vs the costs of same basket in a base period N Price Indext = i N p x it io i pio x io i 1, N drugs Cautionary 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 Are profits in the drug industry “too high?” Return on Assets for Pharmaceutical Companies in the Fortune 500 2008 Profits Rank Company as % of Assets 29 Johnson & Johnson 15.2 46 Pfizer 80 Abbott Laboratories 7.3 11.5 103 Merck 16.5 110 Wyeth 10.0 120 Bristol-Myers Squibb 17.8 122 Eli Lilly -7.1 138 Schering-Plough 6.8 168 Amgen 11.5 The Pharmaceutical industry ranked out of 53 industries with an ROA of 11.5 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 ... are capitalized to the date of marketing approval The cost-of-capital is based on a CAPM analysis of the pharmaceutical industry An 11% real cost-of-capital was utilized for the period under study... differential between brand-name and generic firms = 127%, but brand name market share = 63.4% Pricing Behavior The longer the brand-name drug’s effective patent length, the more market share it... study Millions of 2000 $ Out-of-Pocket and Capitalized Costs per Approved Drug 900 800 700 600 500 400 300 200 100 802 466 336 403 282 121 Pre-Clinical Clinical Out-of-Pocket Total Capitalized