The Hearing Session:
A special National Congress Committee is hearing various groups’ testimonies about the patent laws protecting drug manufacturers. Several people representing cancer patients and their families have testified that they face the excruciating choice of buying groceries for their family or the costly drugs for cancer patients in the family. Two people representing the generic drug manufacturers have testified that if the large pharmaceutical firms licensed drug patents, they would charge a much lower price for the drug, pay a respectful royalty fee, and still make an acceptable profit. A research scientist from the national institute of health has testified that the studies show several thousand Americans die every year because of a lack of access to these drugs. The same witness testified that the public monies spent on the top ten cancer drugs in the US could fund cancer blood screening for every first-grader in the US each year.
Representatives of all the major pharmaceuticals with operations in the US have testified that the costs of developing these cancer drugs are staggering. The discovery-to-market process for a new drug starts from screening from 5000 to 10000 molecules to 250 elected to pre-clinical trials from which ten may pass to clinical trials that can result in one final candidate that can become an approved active ingredient formulated into a final drug delivery system to be sold in the market. This process takes from 10 to 15 years and can cost around 4 – 5 billion dollars. Each of these industry representatives has offered evidence that when a drug goes off-patent, profit drops precipitously. The patent is normally issued very early in the process and if granted provided protection for 20 years. They argue that without patent protection, firms will never be able to recapture all the development costs of a new cancer drug.
Finally, a well-known strategy manager scholar has testified that the drug patent laws represent a market imperfection that has been granted by the government. This scholar testified that if the market imperfection were to be removed, theory predicts that any competitive advantage currently enjoyed by the large pharmaceuticals will likely vanish. The final words of this scholar witness were, “it remains to be seen if drug companies will be willing to make the necessary investments in the development of new drugs in the absence of patent protection.”
Lawmakers then enter into a debate on the fate of patent protection. If they find themselves helping a firm exploit market imperfections, they may be pitting the interest of the firm against the interest of consumers. Do consumers benefit from patent laws anyway? Consumers are forced to pay exorbitant prices for drugs in the presence of patent protection. On the other hand, firms need an incentive to invest in costly research, and that’s the role of patent protection. Is there a place where economic and moral decisions can coexist? Will the research and development companies be motivated to stay in business without reasonable protection?
From the industry standpoint, how would the decision affect the Five Forces Model and the attractiveness of the Industry?
The Pharma Industry Simplified 5 Forces Model.
The branded pharmaceutical Industry (Pharma) consists of firms that develop, patent and distribute drugs. Although there are no significant production economies in this Industry, there are important economies in research and development. Product differentiations exist as well because firms often sell branded products. Firms compete in research and development. However, once a product is developed and patented, competition is significantly reduced. Recently, the increased availability of generic, non-branded drugs has threatened the profitability of some drug lines. Once an effective drug is developed, there are usually few, if any, alternatives to that drug. Drugs are manufactured from commodity chemicals usually available from numerous suppliers. Major customers include doctors, insurance companies, patients, and pharmacies. Recently, the increased costs had led the federal government and insurance companies to pressure drug companies to reduce their prices. The Industry is in good and healthy shape, and the profits make it an attractive business sufficient to keep the interest of the members.
The threat of New Entrants: (weak force)
The pharmaceutical Industry had not seen many new entrants. Barriers to entry are significantly high, given the emphasis on cutting-edge research and development intensity. Costs are very high in this area. With significant barriers to entry in place, potential entrants have little incentive to invest since incumbent firms are earning a competitive advantage. The major barriers to entry include a) economies of scale; b) product differentiation; c) cost advantage independent of scale; and d) government regulation (new drug approval process).
Rivalry among Members: (moderate force)
Rivalry is the intensity of competition among firms’ direct competitors. In the Pharma industry, there are relatively few major drug companies, products are highly differentiated, and the industry growth is strong with plenty of capacity to supply the market.
The threat of Substitutes: (strong force)
Substitutes meet approximately the same customer needs but do so in different ways. Generic drugs are considered substitutes in the Pharma industry since they come with copycat products bypassing the development process. These substitutes place a ceiling on the prices firms can charge and on the profits that they can earn.
Bargaining Power of Suppliers. (weak force)
Suppliers can threaten the performance of firms in the Industry by increasing the price of their supplies or by reducing the quality. Indicators of the threats of suppliers in the Industry include – the suppliers’ Industry is dominated by a small number of firms, and suppliers sell unique or highly differentiated products. In the case of the Pharma industry, members are not important customers for suppliers. The pharma industry is somewhat immune to these threats, given that the raw materials (chemicals) are commodities and available through many suppliers.
Bargaining Power of Buyers: (weak force)
Indicators of increasing bargaining power of buyers in the Industry include – a small number of buyers, industry products are differentiated, and products are a significant percentage of a buyer’s final cost. In The Pharma industry, buyers such as the large high-volume retailers (Walmart, CVS, Costco, among others) can exert some pressure over members but are far away from being successful given the high differentiation that exists among the branded products.
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