The Pharmaceutical Industry Part 2 Professor Vivian Ho Health Economics Fall 2007.

The Pharmaceutical IndustryThe Pharmaceutical IndustryPart 2Part 2

Professor Vivian Ho

Health Economics

Fall 2007

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? 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 BehaviorPricing 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 BehaviorPricing Behavior

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.

These 2 studies suggest that generic drug prices are substantially lower than brand-name prices.

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.

Direct-to-Consumer PrescriptionDirect-to-Consumer PrescriptionDrug Advertising: Bane or Boon?Drug Advertising: Bane or Boon?

Richard L. Kravitz, MD, MSPH

UC Davis Center for Health Services Research in Primary Care

A brief regulatory historyA 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

Promotional spending by Promotional spending by pharmaceutical manufacturerspharmaceutical manufacturers

Are DTC ads reaching Are DTC ads reaching consumers?consumers?

Ads are read and acted uponAds are read and acted upon

56% of Sacramento-area adults have read a DTC ad carefully from beginning to end

35% have asked their doctor for more information because of a DTC ad

19% have asked for a prescription due to an ad

Misconceptions aboundMisconceptions abound

50% believe ads subject to prior review 43% believe only “completely safe”

prescription drugs can be marketed DTC; 21% that only “extremely effective” drugs can be so marketed

22% believe that advertising of prescription drugs with serious side effects has been banned

Are DTC ads educational?Are DTC ads educational?

The Industry PerspectiveThe Industry Perspective

“ By greatly increasing the likelihood that patients will seek help for their medical problems and receive a safe and effective prescribed medicine, DTC advertising will…play a very real role in enhancing public health.”

-Alan F. Holmer, President, Pharmaceutical Research and Manufacturers of America, JAMA 281:380,1999

A Contrarian ViewA Contrarian View

“Extending the scope of already ubiquitous promotions about ‘post-nasal drip,’ ‘unsightly rashes,’ or ‘cures for baldness’ has little to do with educating patients or relieving suffering. It will, however, inevitably drain healthcare dollars, dramatically increase unnecessary prescribing, and strain patient-doctor relationships.”

--JR Hoffman and MS Wilkes, BMJ 318:1301, 1999

Content analysis of print adsContent analysis of print ads

All DTC ads appearing from 1989 through 1998 in 18 popular magazines

Selection of publications based on circulation

ResultsResults

0% 20% 40% 60% 80% 100%

Success Rate

Treatment Duration

Onset of Action

Supportive Behaviors

Competing Treatments

Mechanism of Action

Misconceptions

Prevalence

Precursors

Symptoms

Condition Name

Medical Condition

Codes

TreatmentCodes

Influence on prescribing Influence on prescribing decisions: a bi-national studydecisions: a bi-national study

Cross-sectional cluster survey in Sacramento (CA) and Vancouver (CANADA)

78 primary care physicians 1431 patients (61% of those attending

on preset clinic days)

Patient requests and physician Patient requests and physician prescribingprescribing

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 5.4-14.2)

Provoking clinical ambivalenceProvoking 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 StudiesSummary 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 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.

Capitalized Cost perCapitalized Cost perApproved DrugApproved 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

Out-of-Pocket and Capitalized CostsOut-of-Pocket and Capitalized Costsper Approved Drugper Approved Drug

0100200300400500600700800900

Millions of 2000 $

Pre-Clinical Clinical Total

Out-of-Pocket Capitalized

121

336

466

282

403

802

J. DiMasi, R. Hansen, and H. Grabowski, “The Price of Innovation: New Estimates of Drug Development Costs”, Jan 2002

Pharmaceutical Industry PerformancePharmaceutical Industry Performance

Year All Items Prescription Drugs*1970-79 7.1 3.61980-89 5.6 9.61990-94 3.6 6.91995 2.8 1.92000 3.4 3.62001 1.6 6.02003 1.9 2.52005 3.4 4.42006 2.5 1.9

Urban Consumer Price Inflation Rates

Does the absence of perfect competition higher prices & restricted output?

*2000 onwards includes prescription drugs and medical supplies.

DRUG SPENDING INCREASED 5.4% from 2004 to 2005

IMS Health

4.1%

2.3%

-1.1%

5.4%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

2004-2005

Price Inflation

New Drugs

Utilization &Mix

TOTAL

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.

2006 ProfitsRank Company as % of Assets

36 Johnson & Johnson 15.739 Pfizer 16.899 Merck 9.9102 Abbott Laboratories 4.7113 Wyeth 11.5129 Bristol-Myers Squibb 6.2149 Eli Lilly 12.1171 Amgen 8.7242 Schering-Plough 7.1

Companies in the Fortune 500Return on Assets for Pharmaceutical

Are profits in the drug industry “too high?”

The Pharmaceutical industry ranked 7 out of 74 industries with an ROA of 9.9.

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.