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Price relative to competition: the case of the pharmaceutical industry in Spain.
Subject:
Pricing (Models)
Pricing (Case studies)
Pharmaceutical industry (Prices and rates)
Pharmaceutical industry (Research)
Pharmaceutical industry (Market share)
Authors:
Arranz, Ana Maria G.
Cruz, Natalia M.
Escudero, Ana Isabel R.
Pub Date:
01/01/2004
Publication:
Name: Advances in Competitiveness Research Publisher: American Society for Competitiveness Audience: Academic; Trade Format: Magazine/Journal Subject: Business; Business, general; Business, international Copyright: COPYRIGHT 2004 American Society for Competitiveness ISSN: 1077-0097
Issue:
Date: Annual, 2004 Source Volume: 12 Source Issue: 1
Topic:
Event Code: 604 Market share; 310 Science & research; 740 Commodity & service prices Computer Subject: Product price; Company market share; Company pricing policy
Product:
Product Code: 9914170 Pricing Policy SIC Code: 2834 Pharmaceutical preparations
Geographic:
Geographic Scope: Spain Geographic Code: 4EUSP Spain

Accession Number:
129459323
Full Text:
ABSTRACT

It is accepted that the power of a firm to set up the price for a product above the average price of competitors and to get the acceptation of consumers reflects the superiority of this particular product and, thus, its competitive advantage. This paper tests the hypothesis that the firm ' external and internal factors affect its chances to set a price above the average price of competitors. From a sample of 200 pharmaceutical drugs we find that consumers accept paying an extra price for brands with a larger number of strengths, in early stages of life cycle position, and consumer loyalty and brand image.

INTRODUCTION

The question of why firms pursue different strategies or how firms achieve and sustain competitive advantage has been answered using different theories and approaches (Hoskisson, Hitt, Wan y Yiu, 1999). Industrial Organization Economics and Porter's contributions (1980, 1985, 1986) explain the ability for a firm to gain competitive advantage based mainly on how well it positions and differentiates itself in an industry. And as a refinement of the traditional S-C-P paradigm (structure-conduct-performance), Porter's framework specifies the competitive structure of an industry in a more tangible manner, as well as recognizes (albeit limited) the role of firms in formulating appropriate competitive strategy to achieve superior performance (Hoskisson, Hitt, Wan y Yiu, 1999, p. 426).

The New Institutional Economics gives us the possibility to introduce the rest of the external conditions that affect firm's strategies, that is the institutional environment (the set of fundamental political, social and legal ground rules that establishes the basis for production, exchange, and distribution). For some industries, like the pharmaceutical, the regulation as a part of the institutional environment has to be not just considered but introduced by firms into their strategies in order to achieve competitive advantages.

Those arguments above allow us to present the model in which we consider the factors that influence price decisions and, thus, a competitive advantage for the firm. Next, we develop the relationships described in the model (figure 1).

[FIGURE 1 OMITTED]

THE DETERMINANTS OF THE PRICE RELATIVE TO COMPETITION (PRC)

An external competitive advantage of a product/brand is concerned with those distinctive attributes which provide value to a buyer and allows a firm an edge over its adjoining competitors. Porter defines this advantage in terms of a firm's ability to price higher than the competitors' average price (Porter, 1980). Then, the price relative to competition ratio (PRC), which is defined as the quotient between a firm's product price (Pi) and the average price of its identical competitors (PIC), is a proxy of the competitive advantage of a product relative to the market participants.

To answer the question of why a firm can price higher than its competitors, it is necessary to consider in greater depth those factors related to the PRC of a product. For this purpose, we analyse the following concepts: first, the depth of a brand and scope of the product portfolio and the position of a product within the life cycle (product decisions).

We add public regulation (institutional environment) for each product considering the important regulatory constraints related to the pharmaceutical industry. In particular, the Spanish pharmaceutical market exhibits several specificities that influence the way that pharmaceutical laboratories define their price strategies. On the one hand, we include public regulation as an additional issue that affects price strategies since the upper limit for pharmaceutical drug prices is set by the Ministerio de Sanidad (Health Department). On the other hand, pharmaceutical demand is price-insensitive, both because the patient does not select the drug he or she will consume--instead the physician picks the drug therapy and also chooses either the brand or generic form- and because the patient often does not pay the full price--pharmaceutical drugs, like most other transactions in the health system, are third-party covered and directly provided by the state.

Depth of the Brand, Scope of the Firm Portfolio and PRC

Usually, firms do not pursue single-product strategies but multiple-product strategies. To satisfy a single need, a firm with a deep brand and a large scope portfolio will be better suited to specific segments of the market needs (Kadiyali et al., 1999). As a consequence, a firm is able to set a higher price than competitors as the utility of diversity is more valuable (Borrell, 1999, p. 26) even in the pharmaceutical market. Based on this reasoning, we hypothesize that the depth and the scope of the portfolio is related with the PRC.

H1. The explosion of products within a brand (DEPTH) is positively related to the PRC.

H2. The scope of a product portfolio or multiple brands for a single need (SCOPE) is positively related to the PRC.

Our measures of the depth of a product line (DEPTH) are the strengths for a brand and the number of presentation forms for a brand. The measure of the scope of a portfolio (SCOPE) is the availability of more than one brand for the same pharmaceutical drug.

Position Within The Life Cycle and PRC

Leaders in an industry develop high-pricing strategies for their new products. This is a wise strategy while there are demand-insensibility and high-R&D costs (Dean, 1976; Dolan y Jeuland, 1981). Then, the postulates of the product life cycle say that a price starts decreasing since the former costs decrease and the followers develop new and better products (Scott Morton, 1996; Whitmore, 1997; Schweitzer, 1997; Johnson & Scholes, 2000). Therefore and ceteris paribus, as the time in the market for a product increases, a firm's possibilities to set a price higher to its competitors" price decreases (1).

So, the relationship between time into the market and PRC can not be analyzed without considering the time effect creating a brand image and a consumer loyalty. In the U.S., Abbott (1995) finds that pharmaceutical firms increase the price of their pharmaceutical drugs through time as those products legitimate for consumers (Borrell, 1999, p. 128) and create diffusion effects on the demand-side (Berndt, Pindyck y Azoulay, 1999:20).

Then, there are opposite effects in this variable; however, we hypothesize that the effect of the brand will prevail and we formulate the third hypothesis as follows:

H3. The price relative to competition (PRC) will be positively related to the age of the product (AGE).

Public Regulation and PRC

In most countries, public regulation is a tool to fight against opportunistic behavior and moral hazard of individuals who exchange in imperfect competitive markets (Lobato, Lobo and Rovira, 1997; Puig Junoy, 1998; Borrell, 1999:47). Hence, this regulation is likely to affect a firm's price strategies. In the pharmaceutical market, regulation has a great impact on prices and therefore many researchers have been interested in this particular industry (Scott Morton, 1996; Onishi, 1997; Borrell, 1999; Danzon and Chao, 2000).

H4. The public regulation (PUBLIC) is related to differences in the PRC.

In Spain, public regulation structures the pharmaceutical market in four kind of products: prescription and reimbursed pharmaceutical drugs (Rx), prescription and non-reimbursed pharmaceutical drugs (Rx non-reimbursed), prescription pharmaceutical drugs, before reimbursed and now excluded from the public reimbursement program (2) (Rx excluded) and over-the-counter pharmaceutical drugs (OTC) -those non-risk and non-social interesting pharmaceutical drugs (Lobato, Lobo y Rovira, 1997).

Consumers in this the category of prescription and reimbursed pharmaceutical drugs (Rx) are not price-sensitive but aware of the quality and efficiency of the drug (Masson y Steiner, 1985; Scott Morton, 1996; Getzen, 1997). This interpretation is consistent with the results of Onishi (1997) for the U.S. pharmaceutical market that found that pharmaceutical demands for prescription drugs that the patient pays the full price for is the most inelastic.

H4a. The PRC of the prescription and reimbursed pharmaceutical drugs (Rx NONREIMB) is the highest one.

In the absence of regulation, OTC price is increasing through time since the consumers are more loyal to these brands and the market becomes price-inelastic (Borrell, 1999). Researchers show that in the Rx-to-OTC switching process, pharmaceutical firms have a superior capacity to set prices above the Rx and to get extra net income (Clark, 1996, p.2; Scott Morton, 1996). However, there are specific situations in which this relationship does not hold since patients expect low prices in some categories; there is high competition in some pharmaceutical markets or there are reimbursement policies within the same therapeutic category (Clark, 1996, p.32). Nevertheless, we consider that OTC differential characteristics prevail over the specific situations earlier considered.

H4b. The PRC of the OTC drugs (OTC) is higher than the PRC of the prescription and reimbursed pharmaceutical drugs (Rx).

Finally, the cost control policy engaged in Spain in 1993 and 1998 excluded from the reimbursement program some pharmaceutical drugs, and the positive list system started in 1990 led to a competitive disadvantage for those pharmaceutical drugs excluded from the government reimbursement program (Scott Morton, 1996; Getzen, 1997; Onishi, 1997; Martin and Gutierrez, 2001).

H4c. The PRC of the prescription and non reimbursed pharmaceutical drugs (Rx EXCLUDED) is the lowest one.

Thus, we hypothesize:

Price of Rx non reimbursed > Price of OTC > Price of Rx > Price of Rx excluded

METHODOLOGY

First, we justify the definition of the level of competition for our purposes; second, we describe the sample and, finally, we present the variables. In order to conduct the empirical research, we use the best suited analysis to the characteristics of the variables presented below -the ANOVA procedure and correlation analysis.

A Definition For The Scope Of Competition

The PRC can be calculated using either broad or narrow levels of competition (Lehmann and Winner, 1994; Scott Morton, 1996; Manning, 1997; Danzon and Chao, 2000). Recent studies are still looking for the right level of competition (Onishi, 1997; Wosinska, 2001). In this paper, we estimate the optimal level of competition for identical pharmaceutical drugs: same active ingredient and same presentation: dose, form and pack size. Our dependent variable is the price relative to competition (PRC). PRC is calculated as follows: Pi (drug price)/PIC (identical competitors' average price) and we will refer to it as PRCi.

We restrict the level of competition (Henderson, 1983) with the aim of excluding not related brand-competitiveness variables. We reject the calculation of PRC referred to a broad level of competition (including more than identical/direct competitors (3)).

However, we consider in the analysis another dependent variable (COMPRES): PIC relative to PCC (competitors' average price within a therapeutic category (4)) indicating the competitiveness of the presentation form. Our purpose in introducing this variable in the analysis is to evaluate the factors that could be attributed to higher/lower prices for identical competitors compared with prices of therapeutic competitors and, thus, to estimate the value of the presentation form.

A novel product will be a single-product in a brand and a portfolio. Thus, we hypothesize that the competitiveness of a product (COMPRES) is negatively related to the number of products within a brand ('DEPTH) and the number of brands for a single need (SCOPE).

We expect a positive relationship between the competitiveness of the presentation form and the novelty of the product. So, for COMPRES, we hypothesize that the competitiveness of the presentation form (COMPRES) is negatively related to the age of the product (AGE) -we observe the effects related to the higher PRC of new products and the age of the product as well.

Sample

A sample of 200 pharmaceutical compounds was collected from an universe of 9358 products from Spain for 1999 (5). Sampling procedure was stratified sampling proportionate to the therapeutic category with a 5 percent sampling error. Each compound was characterized by several features: active ingredient, dose, presentation form, pack size and price.

A total of 100 cases had to be deleted from the original sample due to two reasons. On the one hand, it was impossible to compute PRC for 96 pharmaceutical compounds as they lack identical competitors. On the other hand, the four generics included in the sample exhibit several specificities in Spain due to the recent generic law approval in 1997. Their extremely high Pi makes them outliers.

Variables

Drug price (Pi) equals to the price of the milligram of the active ingredient in the pharmaceutical compound. The rest of the variables and their interpretation are in the table 1.

RESULTS

Three main hypotheses (H1, H2, and H3) are supported in dealing with PRCi (Table 2). For H1, a significant positive correlation between PRC and the number of strengths for a brand implies that consumers reward those companies whose products better fit their needs. Those rewards turn up in the acceptance of an extra price for their products. However, H1 is not supported when we refer to the number of presentation forms for a brand. Therefore, that could be interpreted as the pharmaceutical companies not differentiating their products using a large number of presentation forms, but increasing the number of strengths of medication.

The existence of multiple brands in a product portfolio is not associated with PRC so, H2 is not supported. An ANOVA conducted using AGE as independent variable reveals significant differences in PRC (H3). Particularly, older brands exhibit higher levels of brand market power due to brand consumer loyalty and brand image building processes. As we argue earlier, the acceptance of higher PRC is a good indicator of the brand market power. Finally, the ANOVA conducted in order to test H4 shows significant differences on PRC depending on the category of public regulation (6) (Table 3). Rx excluded brands exhibit the lowest relative price value due to the declining of product competitiveness when each decision of exclusion from the public reimbursement program is approved. The brand image of some OTC mostly due to effective direct-to-consumer advertising campaigns explains the value of their PRC in relation to other public regulation categories (i.e. Rx and Rx excluded). More precisely, brand image provokes consumer price-insensibility and this explains why OTC drugs support high levels of PRC. Quality and effectiveness of prescription and non-reimbursed pharmaceutical drugs (Rx non-reimbursed) explain their privileged position in relation to the rest of categories.

The variable competitiveness (COMPRES) outlines a negative significant correlation with AGE. That relationship can be explained as a consequence of the introduction of new presentation forms in the market and the progressive destruction of market power of older categories because of their inability to meet consumer needs.

CONCLUSIONS

The increasing rivalry in the pharmaceutical market urges the need to get competitive advantages to design winning strategies. Thus, a critical knowledge about the factors underlying the market power of a firm above competitors is essential to create successful management practices. The result of this power is the firm's capability to set the prices of its products higher than competitors.

The purpose of this research has been to study the mechanisms that relate external and internal variables of the pharmaceutical firms with the firm's ability to price above competitors in the Spanish pharmaceutical industry, using pharmaceutical drugs as unit of analysis. We found a positive relationship between the price of a product relative to competition and these three following concepts: product line depth, product age, and type of public regulation.

* The consumers' perception that a brand fulfils their needs better than other products (i.e. the product line is wide) implies that they are willing to pay an extra price for this brand. Following this idea, we can recommend a protective strategy from competitors by extending the depth and the scope of a pharmaceutical firm's portfolio. This strategy will keep away consumers from competitor's products to satisfy their needs.

* The consumers' willingness to pay an extra-price for mature medication--those pharmaceutical products that have been long time in the market- is related to its market advantage accumulated through the years. Within the market, as well as in a war, it is less expensive to inforce a protective strategy than a belligerent one. That means, it is easier to defend the pharmaceutical products' positions than try to capture positions of relevant competitors with important competitive advantages.

* Rx not reimbursed status implies superiority in a brand, which is tantamount to higher prices relative to competition. Consumers who buy those products show high price insensibility, which means those individuals are not willing to substitute safety in consumption for price reductions.

The analysis of the competitiveness of the product presentation form shows that the older a product presentation form is--and consequently the more alternative product forms coexist in the market- the lower is the price relative to competition. As a pharmaceutical compound moves through the stages of its life cycle new product presentation forms are introduced in the market involving a better way of fulfilling consumer needs. We could verify that pharmaceutical firms have to renovate periodically their products' portfolio to maintain their competitive advantages. The new presentations--possibly because those forms have a superior adjustment to the market requirements- are more suited to making the consumers to pay an extra price.

In short, our research allows us to state that pharmaceutical companies wishing to set a price above the competitors have to extend the depth of their portfolio; compete in markets or segments with new products that do not have a consolidated brand and competitive advantage; and finally, launch new products periodically within the therapeutic category in which they compete. While those strategies are not feasible, the pharmaceutical company must look for other strategies to compete, for instance, to promote cost competitive advantages to set prices those of the competitors and to get satisfactory rates of return.

However, the use of our conclusions in other industries has to be careful. The relevance of the pharmaceutical regulation on prices in Spain could distort the effect of the rest of the variables. It is the aim of the authors to continue the analysis of the relationships derived from our model in other industries and countries. In addition, we work on the extension of the independent variables that influence the price relative to competition (rivalry and technological obsolescence) and we try to improve the measurement of the variables with more items. Both progress of the research will allow to get more robust conclusions.

(1) Particularly, this reasoning is significant in the pharmaceutical industry as the termination for the patent (20 years) suggests the end of the protection for the product innovation. Laboratories try to recover investments in innovation with high prices (Whitmore, 1997). This period of protection is all the more exploited because after it expires any pharmaceutical firm can launch generics at a very low cost (Scott Morton, 1997).

(2) The cost control policy engaged in 1993 and 1998 is commonly known as "Medicamentazo." For the first time, this decision removed 800 pharmaceutical drugs from the government reimbursement program and the second decision involved another 869 medications.

(3) This level of competition does not include the hospital pharmaceutical drugs taking into account their specific characteristics for commercialization in Spain (Sune y Bel, 1997).

(4) The measures of competition in some researches are related with therapeutic substitutes (Scott Morton, 1996; Manning, 1997; Danzon and Chao, 2000). Those products are chemically distinct compounds that have similar therapeutic effects for at least some patients (Danzon and Chao, 2000).

(5) The sample was collected from the Vademecum (1999). The Consejo General de Colegios de Farmaceuticos de Espana data base is also used as a secondary source of information.

(6) We have to recognize that the sample size for certain categories of public regulation is not big enough to state categorically that H4 can be supported. For research purposes we collected a sample of 200 pharmaceutical compounds representative of the Spanish pharmaceutical market in 1999. In this universe of pharmaceuticals, the Rx category represents the 90 percent of total compounds and the rest of the categories represent just 10 percent.

BIBLIOGRAPHY

Abbott, T.A. (1995). Price regulation in the pharmaceutical industry: prescription or placebo. Journal of Health Economics, 14 (5), 551-565.

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Danzon, P.M. & Chao, L.W. (2000). Does regulation drive out competition in pharmaceutical markets?. Journal of Law and Economics, 43, (October), 311-357.

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Martin Cruz, N. & Gutierrez Arranz, A.M. (2001). Relaciones de agencia en el sector farmaceutico espanol. Marco institutional y decisiones estrategicas. XI Jornadas Hispano-Lusas de Gestion Cientifica, Caceres, Spain.

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Nigel, J.C. (1996). Rx-to-OTC Switching, London: Financial Times, Pharmaceutical & Healthcare Publishing.

Onishi Mortimer, R. (1997). Demand for prescription drugs: the effects of managed care pharmacy benefits. Working paper: Industrial organization seminar economics, University of California, Berkeley.

Puig Junoy, J. (1999). La aplicacion de precios de referencia a los medicamentos. Cuadernos de Informacion Economica, 143, 77-89.

Rao, R.C. & Bass, F.M. (1985). Competition, strategy and price dynamics: A theoretical and empirical investigation. Journal of Marketing Research, 22(3) 283-296.

Schweitzer, S.O. (1997). Pharmaceutical Economics and Policy. New York: Oxford University Press.

Scott Morton, F.M. (1996). The strategic response by pharmaceutical firms to the Medicaid most-favoured-customer rules. Rand Journal of Economics, 28(2), 269-290.

Scott Morton, F.M. (1997). The objectives of the FDA's Office of generic drugs. NBER working paper series, National Bureau of Economic Research, 32.

Sune, J.Ma. & Bel Prieto, E. (1997). Legislacion farmaceutica espanola (11th ed). Madrid.

Tellis, G.J. (1986, October): Beyond the many faces of price: An integration of pricing strategies. Journal of Marketing, 50, 146-160.

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Ana Maria Gutierrez Arranz (anag@eco.uva.es) is Professor in the Department of Economics and Business Administration, University of Valladolid, Avda. Valle Esgueva, 6, 47011 VALLADOLID (SPAIN).

Natalia Martin Cruz (ambiela@eco.uva.es) is Professor in the Department of Economics and Business Administration, University of Valladolid, Avda. Valle Esgueva, 6, 47011 VALLADOLID (SPAIN).

Ana Isabel Rodriguez Eseudero (ana@eco.uva.es) is Professor in the Department of Economics and Business Administration, University of Valladolid, Avda. Valle Esgueva, 6, 47011 VALLADOLID (SPAIN).
TABLE 1
Variables

                           PRICE DECISIONS

PRCi               Price of drug i relative   Calculated as:
(price relative    to identical competitors   "Price of drug i / PCI
to competition)                               "(average price for
                                              identical competitors)."
                                              Numerical variable.

COMPRES            Competitiveness of the     Calculated as:
(competitiveness   presentation form in the   PCI "average price for
of the presenta-   category                   identical competitors"/
tion form)                                    PCC "competitors'
                                              average price within a
                                              therapeutic category."
                                              Numerical variable.

                          PRODUCT DECISIONS

DEPTH              Number of strengths of     Represents the depth of
(depth of the      the brand Number of        a brand or the firm
brand)             presentation forms of      portfolio. Numerical
                   the brand                  variables.

SCOPE              The firm has more than     Categorical variable:
(scope of the      a brand for the same         0 -There are not other
firm portfolio)    molecule                     brands.
                                                1 -There are other
                                                brands.

AGE                Calculated as the          Categorical variable:
(time a drug has   difference between 2000      1 -Between 0 and 10
been on the        and the year when the        years.
market)            drug was introduced on       2 -Between 11 and 20
                   the market (2000-year        years.
                   of drug introduction)        3 -More than 20 years.

                      INSTITUTIONAL ENVIRONMENT

PUBLIC             The drug belongs to one    Represents the
REGULATION         of the 4 types to the      prescription and funding
(prescription      right                      condition for a drug.
and funding                                   Categorical variable.
regulation)                                     1 -The drug is Rx.
                                                2 -The drug is Rx and
                                                not reimbursed.
                                                3 -The drug is Rx
                                                excluded from public
                                                funding.
                                                4.-The drug is OTC.

TABLE 2
Results of the analysis (1)

PRCi (Price relative to identical competitors)

     H1         Correlation --number of strengths-- 0,18 (0,07)
CORRELATION:    Correlation --number of presentation forms--
    DEPTH         0,05 (0,67)

     H2         0 (absence of other brands)    86    1,04
ANOVA: SCOPE    1 (presence of other brands)   13    1,09
                                       TOTAL   ...   1,04
                              F 1,36 (0,25)

     H3         1 (0-10 years)                 50    1,01
 ANOVA: AGE     2 (11-20 years)                32    1,06
                3 (more than 20 years)         14    1,11
                                       TOTAL   ...   1,04
                              F 3,25 (0,04)

COMPRES (present. form competitiveness)

     H1         Correlation --number of strengths-- -0,14 (0,06)
CORRELATION:    Correlation -number of presentation forms--
    DEPTH         -0,05 (0,57)

     H2         0 (absence of other brands)    85    0,992
ANOVA: SCOPE    1 (presence of other brands)   13    0,989
                                       TOTAL   ...   0,990
                             F 0,003 (0,95)

     H3         1 (0-10 years)                 49    1,00
 ANOVA: AGE     2 (11-20 years)                32    1,00
                3 (more than 20 years)         14    0,91
                                       TOTAL   ...   0,99
                              F 2,88 (0,06)

TABLE 3
Results of the Analysis (II)

                                PRCi

H4              1 (Rx)                 92    1,04
ANOVA: PUBLIC   2 (Rx no reimbursed)   1     1,44
                3 (Rx excluded)        3     0,94
                4 (OTC)                3     1,14
                               TOTAL   ...   1,05

                         F 3,79 (0,01)
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