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.
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
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
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
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,
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
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
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
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.
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
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.
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.
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.
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
* 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
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,
(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.
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Ana Maria Gutierrez Arranz (email@example.com) is Professor in the
Department of Economics and Business Administration, University of
Valladolid, Avda. Valle Esgueva, 6, 47011 VALLADOLID (SPAIN).
Natalia Martin Cruz (firstname.lastname@example.org) is Professor in the
Department of Economics and Business Administration, University of
Valladolid, Avda. Valle Esgueva, 6, 47011 VALLADOLID (SPAIN).
Ana Isabel Rodriguez Eseudero (email@example.com) is Professor in the
Department of Economics and Business Administration, University of
Valladolid, Avda. Valle Esgueva, 6, 47011 VALLADOLID (SPAIN).
PRCi Price of drug i relative Calculated as:
(price relative to identical competitors "Price of drug i / PCI
to competition) "(average price for
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
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
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.
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
3 -The drug is Rx
excluded from public
4.-The drug is OTC.
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)
Results of the Analysis (II)
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)