The ECONOMICS

of
Pharmaceutical Industry

Drugs: Who Pays?

55% out-of-pocket
25% private insurance

17% public insurance

3% Other

The Pharmaceutical Industry develops, produces, and

markets drugs or pharmaceuticals licensed for use
as medications

Pharmaceutical comes from the Greek

word Pharmakeia.
The modern transliteration
of Pharmakeia is Pharmacia

Benefits of Drugs

Reduce mortality

Reduce morbidity/improve
quality of life
Reduce cost of treating
diseases

HISTORY
The origins of the pharmaceutical
industry can be traced back to the
chemical industries (of the late
nineteenth century) in the upper Rhine
Valley of Switzerland. These industries
were producing dye. When dye stuffs
were found to have antiseptic
properties, a number of these industries
turned into pharmaceutical industries
e.g. Hoffman-La Roche, Sandoz, CibaGeigy, etc.
Key discoveries of the 1920s and 1930s,
such as insulin and penicillin, became
mass-manufactured and distributed.
Switzerland, Germany, Italy, UK, US,
Belgium and Netherlands, had strong
industries.

 As a result of introduction and success of

penicillin in the early forties and the
relative success of other innovative drugs,
research and development (R&D) became
a major thrust area of the pharmaceutical
industry.
The industry expanded rapidly in the
sixties, benefiting from new discoveries. In
the1960s attempts were made by the U.S.
Food and Drug Administration (FDA) to
increase regulation of pharmaceutical
industries and to limit financial links
between companies and prescribing
physicians. In 1964, after the thalidomide
tragedy (in which the use of a new
tranquilizer in pregnant women caused
severe birth defects in the new born
child), the World Medical Association set
standards for clinical research.

HISTORY
. Drugs for heart disease and for AIDS were a feature of the 1980s,
and the US FDA started approving such drugs quickly keeping in
view the nature of the disease. Legislation allowing strong patents,
to cover both the process of manufacture and the specific products
came in to force in most countries, and the small industries were hit
by this and many closed down or were taken over by large
industries. In 1990s and till date a number of mergers and
takeovers have taken place. As a result pharmaceutical
manufacturing became concentrated, with a few large companies
holding a dominant position throughout the world.
Tighter regulatory controls were introduced in the seventies.
The new regulations revoked permanent patents and established
fixed periods on patent protection for branded products. As a
result industries flourished by producing generic products and they
started earning huge profits, because generic manufacturers do not
incur the cost of drug discovery.
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HISTORY
Some of the best
pharmaceutical industries
spread all over the world are
Novartis, Pfizer, Bayer, Glaxo
Smith Kline, Johnson and
Johnson, Merck & Co., Abbott
Laboratories, Procter & Gamble,
Wyeth , Dr.Reddys, Ranbaxy,
etc.

HISTORY
Another origin is the drug store. The
first known drug store was opened by
Arabian pharmacists in Baghdad in
754, and many more soon began
operating throughout the Islamic
world and Europe. By the 19th century,
many of the drug stores in Europe and
North America had developed into
larger pharmaceutical companies.
Most of today's major pharmaceutical
companies were founded in the late
19th and early 20th centuries.

HISTORY
From 1978, India took over
as the primary center of
pharmaceutical production
of bulk drugs and products
without patent protection.
The industry remained
relatively small scale until
the 1970s when it began to
expand at a greater rate

Outline
Competitiveness of the pharmaceutical
industry
Conduct
Performance

Industry Structure

COMPETITIVENESS

COMPETITIVENESS

The bargaining power of suppliers

Providers of the raw materials and

intermediates
manufacturing and production plants
the overseas head offices who supply
finished product
the local co-marketing partners who
supply product and/or third party
suppliers
Labor

Suppliers can affect in several

ways: by threatening to raise
prices or threatening to reduce
the quality of goods and services.
Both these prospects are
unattractive to a business
because of their affect on
profitability.

The bargaining power of buyers

In the pharmaceutical industry, the buyers

are the patients, the family
members(indirecty), the finance
departments, the hospital boards, the
tender boards, the chief pharmacist along
with a range of other buyers, depending
on the specific business.
Their influence needs to be considered. In
various ways, buyers can affect a business
by seeking price reductions, - demanding
higher quality and demanding better
service.
A buyer is powerful in the following
situations:
when they purchase large volumes,
when they buy your products from other
suppliers because they are standardised
when they are knowledgeable and make
demands based on this knowledge.

How 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 government medical programs

Drug utilization review

Used by insurers to enforce formularies, identify
inappropriate prescribing practices

Government influence

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?

The threat of substitutes

Substitute products
perform the same
function as the product,
and are a competitive
force as they can take
away demand or tie up
those customers who
choose to use the
substitute instead of
your product.

The threat of new entrants

New entrants into the industry affect the
competitive dynamics and need to be
taken into consideration when analysing
the competition
Possible barriers for the new entrants
Economies of scale - manufacturing,
R&D, marketing, sales, distribution.
Product differentiation - established
products, brands and relationships
Capital requirements and financial
resources
Access to distribution channels:
preferred arrangements
Regulatory policy: patents, regulatory
standards
Switching costs - employee retraining,
new equipment, technical assistance

Government 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

always strong
Patents granted for chemical composition,
not therapeutic novelty
Lipitor, Crestor, and Zocor all compete in the
cholesterol-lowering drug market

Significant part of patent life may be spent

trying to get FDA approval
effective patent life = 8 years

The intensity of rivalry among competitors

It occurs among competitors
because one or more of them either
feels the pressure or sees the
opportunity to improve their
position in the market place.
This rivalry among firms usually
takes the form of jockeying for
position using tactics like price
competition, advertising battles and
product introductions. It can be
intense if companies are scrambling
for market share, but if the overall
market is in growth or the position
of the company is protected
through patents, then the rivalry is
likely to be less intense.

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Top 10 U.S. Prescription Drug Sellers, 2008

Company
Sales $b
Pfizer
20.5
GlaxoSmithKline
18.4
AstraZeneca
16.3
Johnson & Johnson
16.0
Merck & Co
15.5
Amgen
13.4
Hoffman-LaRoche (incl Genentech) 13.1
Novartis
12.4
Lilly
11.4
Sanofi-Aventis
11.0

http://www.imshealth.com

CONDUCT

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Prescription Drugs
10,000 FDA-approved
drugs
70% of all office visits
lead to prescriptions
1.5 - 2.0 billion
prescriptions/year

Influences on Physician Prescribing

Habits

Texts
Journals
Colleagues
Formularies
Samples
Patient requests
Personal experience
Cost
Gifts
Drug advertisements
Pharmaceutical
representatives

Gifts from Pharmaceutical Companies

Pens, toys and puzzles

Household gadgets
Food
Books
Event tickets
Travel and meeting expenses
Cash

AMA Guidelines Re Gifts to Physicians

from Industry
Gifts of modest value which benefit patients O.K.
Pens, notepads, modest meals, textbooks acceptable
Film, videos, CDs; Dinner to Go (Merck); Look for a
Book GlaxoSmithKline PLC); Palm Pilots (Dupont) may
be acceptable
No cash gifts
No gifts with strings attached
CME sponsorship money to conference sponsor, not
participating physicians
Meeting expenses for trainees funneled through institution

Pharmaceutical Company Advertising

$15 billion in 2000
up to $15,000/U.S.
physician
over $6 billion advertising and
marketing
over $7 billion - sales
reps salaries
50,000 salespersons:
1/10 prescribing
physicians

Pharmaceutical Company Advertising

Drug Samples
$8
Only of samples
billion/year
go to patients
60% of
in samples
Dispensed at
10% - 20%
of visits

pharmaceutical
reps selfmedicate
50% of residents
self-medicate,
often using
samples

Truthfulness in Drug Ads

Wilkes et al.
Ann Int Med 1992:116:912-9

10 leading medical journals

109 ads and all available references (82%)
3 independent reviewers

Doctors are Influenced by Pharmaceutical

Advertising and Marketing
Prescribing patterns
e.g., Calcium channel blockers
1998: Trovan most promoted drug
in US; sales most ever for an
antibiotic in one year; use since
limited by FDA due to liver toxicity

Doctors are Influenced:

Formulary Requests
by P and T Committee Members
(JAMA 1994;271:684-9)

Met with drug rep 3.4X more likely to

request companys drug
Accepted money to speak at symposia 3.9X
Accepted money to attend symposia 7.9X
Accepted money to perform companysponsored research 9.5X

Pharmaceuticals Sales Reps

Techniques

Appeal to authority
Appeal to popularity
The red herring
Appeal to pity
Dryden - Pity melts the mind
Appeal to curiosity
Free food/gifts
Testimonials
Relationship building/face time
Active learning reinforcement / change
Favorable but inaccurate statements
Negative comments re competitors
products
Reprints not conforming to FDA
regulations

PERFORMANCE

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Economics
16.4% profit margin in 2000 ($24 billion)
-Largest of any industry
-4 times greater than average return of all
fortune 500 companies
-8 out of 25 most profitable U.S.
companies are pharmaceutical companies
Greater than 5000 companies worldwide
Less than 100 companies account for over
90% of worldwide market

World Pharmaceutical market

Total worldwide sales of pharmaceutical products were about $291 trillion

41

Market Shares of Leading Pharmaceutical Companies

42

Manufactures' Sales by Class of Customer

43

Mergers and Acquisitions

Drug company mergers
- Pfizer-Warner-Lambert
- Upjohn-Pharmacia
Pfizer acquired Pharmacia in 2002 for
$60 billion to become the worlds most
powerful drug conglomerate

Drug Costs
U.S. highest in the world
55% > Europe
35% to 80% > Canada (drug companies still
among the most profitable in Canada)
Cross border pharmacy visits increasingly
common
Canada vs. Mexico

U.S. only large industrialized country which

does not regulate drug prices
Single payer system would dramatically
decrease drug costs
Single purchaser able to negotiate deep
discounts

Increasing Involvement of Industry in

Provision of Continuing Medical Education
1/2 of the $1.1 billion spent on CME in 1999
from industry
Medical Education and Communication
Companies
Sponsored/paid mainly by drug companies
Provide educational materials gratis

Where Prescription Peso Go

Research and development - 12%
-preclinical testing - 6%
-clinical testing - 6%
Manufacturing and distribution - 24%
Sales and marketing - 26%
Administrative / miscellaneous expenses - 12%
Taxes - 9%
Net profit - 17%

Conclusion
Pharmaceuticals and Biotechnology
Industries
-Tremendous contributions to
health
-Motivation = alleviate suffering
-Primary responsibility = make
money for shareholders

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