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Competition in the pharmaceutical industry: how do quality differences shape advertising strategies?
Maria-Angeles de Frutos1, Carmine Ornaghi, Georges Siotis
1Department of Economics, Universidad Carlos III de Madrid, Spain.
Journal of Health Economics
|December 15, 2012
Summary
Higher quality prescription drugs receive more advertising. This study models price and advertising competition, showing firms use promotions to build brand loyalty and extract higher profits, with empirical data supporting these findings.
Area of Science:
- Health Economics
- Pharmaceutical Marketing
- Industrial Organization
Background:
- Prescription drug markets feature intense competition based on price, quality, and advertising.
- Consumer behavior in these markets is influenced by factors like brand loyalty and perceived drug efficacy/side effects.
Purpose of the Study:
- To develop a theoretical model of price and advertising competition between differentiated prescription drugs.
- To empirically investigate the relationship between drug quality, advertising intensity, and market outcomes.
Main Methods:
- A Hotelling model was employed to analyze price and advertising competition between drugs of varying quality and side effect profiles.
- The model incorporated endogenous consumer segmentation into brand-loyal and non-brand-loyal groups based on promotional effort.
- Empirical analysis utilized product-level data on prices, quantities, advertising, and drug quality information from the FDA's Orange Book.
Main Results:
- Advertising intensities were found to be strategic substitutes.
- Higher quality drugs were associated with greater advertising expenditures.
- This positive association is driven by firms' ability to extract higher rents from consumers with endogenously determined brand loyalty.
Conclusions:
- The study provides strong empirical support for the theoretical predictions of the Hotelling model regarding advertising and pricing strategies in the pharmaceutical market.
- Promotional efforts play a crucial role in shaping consumer loyalty and influencing competitive dynamics between prescription drugs.
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