Market definition in the pharmaceutical industry: a case of drugs
hoping antitrust markets?
Abstract
Market definition plays a central role in the conduct of competition policy. On both
sides of the Atlantic, identifying market boundaries forms part of the case assessment
when it comes to mergers and monopolisation/abuse of dominance cases. Once
established, the competitive analysis is carried out within the boundaries of the
antitrust market. It is common for competition authorities to rely on precedent, i.e.
stick to a particular market definition. In this paper, we show that, contrary to
established wisdom and practice, the delineation of an antitrust market can evolve
fast. In addition, we highlight the importance of properly accounting for non-price
instruments; ignoring them can easily lead to a flawed definition of the antitrust
market. We do so by econometrically estimating substitution patterns in the
pharmaceutical industry. Our findings have important implications for abuse of
dominance (monopolisation) cases in jurisdictions such as the EU that put a heavy emphasis of market definition.
JEL Classification: D22, I11, L13 Keywords: market definition, pharmaceutical industry, competition policy, antitrust
1 University of Southampton 2 Universidad Carlos III de Madrid and CEPR. Georges Siotis gratefully acknowledges the financial support from the Ministerio Economía y Competitividad (Spain) grants Beca I3 2006/04050/011, ECO2015-65204-P, MDM 2014-0431, and Comunidad de Madrid grant MadEco-CM (S2015/HUM- 3444). 3 ECARES (Université Libre de Bruxelles -SBS-EM) and CEPR. Micael Castanheira is Directeur de recherche FRS-FNRS and gratefully acknowledges their financial support.
2
1. Introduction
In competition policy practice, a “relevant market” is the set of products over a
certain geographical area that a firm would have to control in order to be able to
exercise substantial market power (i.e. no longer be constrained by competitors).
As pointed by Motta (2004), market definition is of no intrinsic interest: it is just a
“preliminary step towards the objective of assessing market power” (Motta 2004,
p. 101). The purpose of market definition is then to identify in a systematic way
the competitive constraints that firms are faced with (Market Definition Notice, OJ
1997). Once the relevant market has been identified, the competitive assessment
can be carried out within the boundaries of this market. Computing market shares
can be a determinant factor to assess whether a firm enjoys a position of
dominance or to infer the effect of a proposed merger. Indeed, according to EU case
law, a condition to open proceedings is that the firm enjoyed a dominant position
at the time of the abuse and a necessary (but not sufficient) condition to establish
dominance is that the firm’s market share be above a certain threshold.4 Similarly,
in the case of mergers, the combined market shares are used as a first step in the
competitive assessment.
There are sound analytical foundations underpinning the importance assigned to
market definition. For instance, in the Cournot model, in which firms
simultaneously choose the quantity of a homogeneous good, one can establish a
one-to-one link between the firms’ Lerner index and market share. In such a
setting, a firm’s market share is a sufficient statistic to infer its ability to price
above marginal cost.5 However, in the presence of product differentiation, be it
vertical, horizontal (or both), market definition is more complex (see appendix for
more details).
While enforcement agencies do not set any particular market definition “in stone”,
they are very cautious to modify a particular assessment (Motta, 2004). As a
general rule, this may be desirable to provide legal certainty. There are of course
exceptions to this rule. Some cases justify a reassessment of the market definition.
For instance, new products, whether introduced by existing competitors or by new
entrants, may subject the industry to profound changes. Other instances include
sweeping technological advances, or market widening following some sort of
liberalisation (e.g. removal of barriers to trade). As far as we are aware, there is no
instance of an authority altering its assessment of market boundaries in the
absence of such regulatory change, technological improvement, or market
liberalization.
4 With a share of 50% or above, there is a presumption of dominance. Between 40 to 50%, there may be dominance but the market share criterion should be complemented with evidence pointing to dominance. Below 40%, there is presumption that dominance is not present. This illustrates how important the computation of the market share may turn out to be. 5 The link breaks down in a stylized market that sells a perfectly homogeneous good, when firms compete
in prices and face no capacity constraint (Bertrand competition). In that case, for any n > 1 and in the
absence of collusion, firms enjoy no market power, irrespective of their market share. The link between
market share and ability to price above marginal cost is recovered once capacity constraints are binding
(Kreps and Scheinckman, 1983); a condition often met in the “real world”.
3
This paper investigates whether, in the context of the pharmaceutical industry,
patent expiration leads to significant changes in market boundaries. Our interest in
exploring this question is driven by the fact that patent expiration, as documented
in Section 2, is generally accompanied by a drastic reduction in promotion. Based
on previous research (Castanheira et al. 2017), we conjecture that this drop is
likely to curtail the competitive pressure that a molecule exercises on its patent
protected peers following Loss of Exclusivity (LoE). In other words, we claim that
market boundaries are shaped by advertising and therefore generic molecules
effectively “drop out” of the relevant market following LoE. It is important to note
that this change in the relevant market occurs over a short period of time (around
LoE) and does not stem from technological and regulatory change, nor the result of
trade liberalisation or the launch of a new product.
Our empirical approach consists in estimating price and advertising elasticities to
identify substitution patterns that lie at the core of market definition. For this we
exploit an unusually rich dataset comprising price, quantity and promotional effort
for hundred molecules sold in the US during forty quarters. We show that patent
expiration of branded drugs leads not only to a drastic reduction in the price, as
generic versions of the same molecule enter the market, but also to an equally
dramatic decrease in the advertising of the drugs losing patent protection. These
changes in prices and advertising strategies are likely to shape the choice set of doctors and patients, thus potentially affecting market boundaries.
Our point is that, counterintuitively, the launch of a generic version of an existing
drug may shrink—instead of expand—market boundaries. Preliminary results
seem to support this view. In particular, in Section 3 we show that on patent drugs
are only constrained by their on-patent peers. In addition, we show that “former”
on-patent molecules stop exercising a competitive constraint once they experience LoE.
The rest of the paper is organized as follows. Section 2 describes the dynamics of
competition in the pharmaceutical industry before and after patent expiration. In
Section 3 we describe the data, introduce the empirical framework and provide
evidence on shifting market boundaries. Section 4 extends the analysis to the post
LoE environment by identifying both intra- and inter-molecular competitive
constraints faced by individual generic producers. Finally, in Section 5, we discuss
the policy implications of our results and directions for future research.
2. Competition Dynamics in the Pharmaceutical Industry.
In order to properly identify competitive constraints, it is necessary to identify
competitive interaction in a given market. This is particularly relevant when firms
compete with price and non-price instruments, and/or other forms of public
interventions may dampen the role of price as a competitive tool (Sovinsky Goeree
2008). In the next subsections, we describe the evolution of price and non-price
instruments (promotional effort), during different moments of a drug’s life cycle,
highlighting their importance at each stage.
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2.1 Stage I: Product Development and Market Authorization
The first step in the discovery of a new drug consists in screening thousands of
chemical and biological compounds to identify molecules that exhibit the potential to treat a certain condition.
Once a drug receives marketing authorization, a “reference” price is set. In
Continental Europe, this results from negotiations between pharmaceutical
companies and social security systems that enjoy substantial bargaining power.
The resulting price acts as a binding, fixed price cap (in theory, pharmaceutical
companies can lower their price below the reimbursement price). In the US,
private insurance companies, Health Management Organisation, corporations that
offer their own specific package negotiate at what prices drugs will be eligible for
insurance coverage. Similarly to Europe, these private entities have bargaining
power (in Japan, the insurers have little bargaining power, see Iizuaka 2012).
Hence, while pricing is set freely in the US, the reimbursed price acts as a de facto
lid on prices, since the most drug sales are covered by some form of insurance
coverage.
When determining the reimbursement price, insurance companies/health
authorities factor in the availability of existing drugs. All else equal, the re-
imbursement price is likely to be lower the greater the availability of therapeutic
substitutes. By contrast, the maximum price is likely to be set at a high level for
drugs that represent a genuine therapeutic breakthrough. The fact that insurance
companies/health authorities establish a maximum price (that is not lowered
unilaterally thereafter) is compatible with the conjecture that firms would have
chosen higher prices had they been free to do so. More importantly, the
mechanism to establish a re-imbursement price clearly indicates that drugs that
are therapeutic substitute compete with each other, even before product launch.
2.2 Stage II: Product Market Competition prior to LoE
Once the drug has received regulatory approval and reference price is established,
firms compete for patients. To a significant extent, the nature of the competitive
interaction depends on the characteristics of demand.
The vast majority of patients are uninformed about the intrinsic characteristics of
a particular drug. For instance, the existence of side-effects can affect well-being
and/or compliance with a particular treatment. In addition, medical expertise is
required to determine, ex-ante, the optimal drug choice from a therapeutic
perspective. This information asymmetry means that patient's role is passive in the
sense that it is limited to describing his/her condition and his/her reaction in
terms of effectiveness and incidence of side-effects. As a general rule, patients do
not determine the particular drug (or combination thereof) that they are
prescribed. In addition, the deciding agents (doctors) generally do not bear any
direct cost associated with their prescription choices (except in the case of demonstrated bad praxis).
5
Such forces limit the scope for price competition prior to the entry of generic
versions of a particular molecule. However, at least in the case of the US, Third
Party Payers (TPP) such as Health Management Organisations (HMOs), Pharmacy
Benefit Managers (PBMs), and patients who pay out of pocket, ensure that demand
remains sensitive to price. In addition, for drugs sold to hospitals, price influences
managers’ recommendations regarding the most cost effective treatment.
Price competition while firms are still covered by IP rights is coupled by tough
competition through advertising and promotion. According to figures in Donohue
et al. (2007, p. 497), in 2005, originator firms spent, on average, 18% of the
revenues on promotion in its various forms: detailing, distribution of free samples,
and adverts in specialised journals. Detailing consist of individual visits by sales
agents to provide information to practitioners. In the US, this is complemented by
Direct-to-Consumer Advertising since 1997. The amounts spent on promotion are
slightly above R&D expenditure, indicating the strategic role played by it. In the
Astra Zeneca case, the European Court of Justice confirmed the importance of
promotional effort in the competitive process.6
Lowe (2013) provides more recent figures to the same effect. The accounting
category where advertising, promotion, and marketing end up is now called
“SG&A” (Sales, General and Administrative). This is a broader group as it also
includes executive salaries. Lowe (2013) reports “that Merck’s [SG&A] are at 27%
of revenues [R&D: 17.3%], Pfizer is at 33% [R&D: 14.2%], AstraZeneca is just over
31% [R&D: 15.1%], Bristol-Myers Squibb is at 28% [R&D: 22%], and Novartis is at
34% [R&D: 22% according to their 2013 financial report]”. For comparison, SG&A
represents 21.5% of IBM’s sales, 20% of 3M’s and 6.5% of Apple’s.
As compared to price, promotion is more volatile. Using data from IMS-Health, we
measure the firms' drug-specific spending on personalized visits to general
practitioners and hospital specialists, free samples dispensed to physicians, and
advertising in professional journals. All these instruments affect doctors'
incentives to prescribe one rather than another drug to their patients. Figure 1
shows that, in the sample used for our empirical analysis (detailed in Section 3),
prices vary much less than promotion. As mentioned above, this is due to the fact
that, while pharmaceutical companies are free to set the prices of their new drugs
and change them over time, prices need to be negotiated with insurance
companies, health maintenance organization and major chains of pharmacy stores
and hospitals. By contrast, promotion levels can be chosen at will. These facts
suggest that promotion is a central competitive tool used by pharmaceutical companies to increase volume and market shares of their products.
6 In Case T-321/05, paragraph 210, Astra Zeneca, July 1 2010, the European Court of Justice ruled
that “… the Commission was accordingly justified in taking the view that the market introduction of
ranitidine led to increased competition between H2 blockers through increased promotional
activity…”.
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Figure 1: Price and Advertising of Drugs covered by Patent Protection
2.3 Stage III: Product Market Competition after LoE
There is overwhelming evidence that own generics exercise a unique constraint on
drugs that were once protected by IPRs. Generics are typically sold at half the
price of their branded equivalent and exert strong competitive pressure on the
original branded product: Grabowski et al. (2014) show that, for branded drugs
that faced generic entry in 2011-2012, brands retained, on average, only 16% of
the molecule market after 1 year. This is not surprising, as generics are a
bioequivalent product that has been explicitly recognised as such by health
authorities.
colours); hence, it is reasonable to expect intra-molecule competition to converge
to the Bertrand outcome in the absence of capacity constraints. However, some
practitioners/patients may be brand loyal and still prefer the originator drug even if it is more expensive.
Figure 2 illustrates the dynamics of quantity and prices for 94 molecules that
experienced generic entry in the U.S. during the period 1994-2003. Time is
expressed in quarters and we denote as “date 0” the quarter when firms lose
exclusivity. We normalize values to 1 at quarter -12. Before patent expiration, the
price of the original molecule is slightly increasing. Then, within a year of the loss
0 5
1 0
1 5
2 0
-.5 0 .5
Price Growth Promotion Growth
Obs 2416 Price: Mean .006% SD .112 - Prom: Mean -.028% SD .395
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of exclusivity (LoE), mean (respectively, median) prices drop by about 30% (20%).
Within three years, the drop reaches about 60% (40%).7
Figure 2: Price and Quantity around Lost of Exclusivity
Figure 2 presents a surprising piece of evidence: despite being sold at a fraction of
the original price, the genericized molecule actually experiences a steep drop in
volumes after LoE: average and median quantity drop by 20% three years after
patent expiry. In other words, after LoE, the combined volumes of the branded and
generic producers are substantially below the volume of the single branded drug when it was sold at a price embodying monopoly power.8
Another perplexing feature surrounding generic entry is that the price of the other
on patent molecules does not decrease (Jena et al. 2009). And yet, as we can infer
from Figure 2, they experience a gain in market share. Put differently, few new
patients are directed to the cheap genericized molecule, whereas some others
7 Although the average price of the molecule (displayed) falls following generic entry, this is not
always the case for the price of the branded drug (not separately depicted in Figure 2). Sometimes,
the latter remains constant or even increases; this is the so-called generic entry paradox (for
empirical evidence, see Regan (2008) for the U.S., and Vandaros and Kanavos (2013) for the EU).
This behaviour is usually attributed to the fact that a subset of patients insists on purchasing the
brand, even at a higher price. This allows branded producers to keep extracting rents on a
(shrinking) subset of patients.
8 Jena et al. (2009) report similar findings: "[f]or five major classes of drugs, we find that large reductions in the price of pioneer molecules after patent expiration ---which would typically lead to decreased consumption of strong substitutes---have no effect on the trend in demand for follow-on drugs."
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switch towards competing molecules precisely when their initial treatment
becomes cheaper (see European Commission, 2009). Neither the rationales for the
so-called generic entry paradox, nor co-payment by health insurances may explain
why cross-price elasticities suddenly seem to take “the wrong sign”.
Jena et al. (2009) interpret the absence of price reaction by competitors and/or
demand shifting towards generics as evidence of single molecule markets, without
actual substitutability. The implication would be that patented molecules --
including competing “me-too drugs” in the same therapeutic market-- are
“monopolies. This conjecture contradicts vast evidence pointing to fierce
intermolecular competition while all molecules are patent-protected. Taken
literally, Jena’s et al. (2009)’s conclusion would imply that relevant markets are
made-up of a single drug. A similar approach has been applied by the EU
Commission in the Servier case, where the hypertension drug perindopril (an ACE
inhibitor) was deemed to form a market on its own.9 In part, this conclusion was
motivated by the observation that the drop in price associated with generic entry
into other ACE inhibitors did not seem to affect the sales of perindopril.
We conjecture instead that the lack of response of on-patent drugs to low prices of
genericised competitors can be traced back to the significant drop in promotional
effort around the time of patent expiration. To this end, in Figure 3, we show how
total spending on promotion evolves around the time of LoE in the case of
molecules that were actively promoted. Our data reveal that promotion falls
continuously over the 12-quarter period before patent expiration, with a sharp
drop in the median spending at the time of LoE. At time 0, promotion effort has
dropped by 50%. Soon after patent expiration, the median spending is zero.10 This
graphical evidence suggests that the drop in competitors’ price is more than offset
by the drop in promotional effort.
9 Case AT.39612 – PERINDOPRIL (SERVIER), July 9 2014. In recital # (2549), the Commission
concluded that: “The relevant market is defined as comprising of original and generic perindopril in each of the four national markets defined above”. 10 The average lies above the median because some molecules keep being promoted. For instance, high level of promotions are observed for Prozac (fluoxetine) because Eli Lilly & Co. introduced weekly delayed release capsules of the drug just before LoE in an attempt to stem the post-patent decrease in sales of their daily dosage. Similarly, we observe positive spending for Zantac (ranitidine) and Tagamet (cimetidine) probably because some of their lower-dosage tablets are available over-the-counter (no prescription required).
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Figure 3. Evolution of Price and Promotion.
In Castanheira et al. (2017), we provide a model that rationalises the evidence
presented above.11 An implication of the model’s finding is that a product that was
exercising a competitive constraint on rival products may suddenly drop out of the
(antitrust) market. It does not drop out in a physical sense (the product continues
to be sold), nor are guidelines regarding intended use changed. It drops out of the
market in an economic sense: it stops exercising significant competitive pressure on
the products that were rivals pre LoE. Put differently, it is not because a product
does not exercise a competitive constraint at time t that it did not exercise a
competitive constraint at time t-k. In the context of the Servier case, this would
imply that while genericised ACE inhibitors no longer exercised a constraint on
perindopril, they may have done so while they were on patent.
Section 3 and 4 present our core results. In Section 3, we propose an empirical
framework to determine whether cross-price elasticities change over a drug’s life
cycle. The objective is to assess whether the competitive constraint exercised by a
given drug is constant overtime or whether it varies post LoE. In Section 4, we spell
out a complementary framework to identify both intra- and inter-molecular competitive constraints faced by individual generic producers.
11 See Lu and Ray (2017), the Antitrust Source (American Bar Association), for an extensive summary of Castanheira et al. (2017).
10
3.1. Data
Market definition in the pharmaceutical industry is not straightforward (Morse,
2003, Browdie et. al. 2018). The empirical exercise we carry clearly identifies the
importance of promotion and, by extension, non-price instruments at the time of
defining relevant markets.
Our dataset covers quarterly dollar revenues and physical quantities for hundreds
of branded and generic prescription drugs sold in the U.S. in many therapeutic
areas over the 40-quarter period 1994q1 to 2003q4. These have been obtained
from the proprietary database IMS-Health, one of the most important medical-
information providers (IMS-MIDAS).
All the drugs in IMS-Health are classified according to the Anatomical Therapeutic
Chemical (ATC) classification system. The ATC3 level corresponds to a market: it
groups the drugs that target a given condition. The ATC classification is based on
therapeutic modes of action and is recognised as a valid grouping method by
professionals. In addition, the EU Commission routinely takes the ATC3 three level
as the starting point to define the relevant market (Greenaway et al. 2009).
In the IMS data, generics have the name of the active ingredient. We thus compiled
an initial list of ATC3 markets with generic entry by selecting the markets where
there are at least two different products for the same molecule, and some of the
drug names are the same as the molecule (e.g. Fluoxetine is the active ingredient of
Prozac), as well as the name of its generic competitors. The list of molecules, their therapeutic class and the date of LoE is provided in the Appendix.
We double-checked and completed this list with information about Loss of
Exclusivity (LoE) from the FDA and other resources. We then purchased drug-
level information on promotion expenditure for the most important ATC3 markets
in terms of sales and promotional effort. The final sample we assembled for the
empirical analysis includes 53 different ATC3 markets..
For each of the drugs belonging to the selected markets, we computed deflated
revenues (R) by dividing nominal value of sales by the producer price index for the
pharmaceutical industry published by the Bureau of Labor Statistics. Quantities (Q)
are reported in standard units that represent the number of dose units sold for
each product; this corresponds to one capsule or tablet of the smallest dosage or
five millilitres of a liquid (i.e. one teaspoon). Standard units allow comparison
across different drug forms and dosages, as all different packages are subsumed
into the same unit of observation. We then compute the average price of a
molecule (P) by dividing R -i.e. the revenues for all the different packages- by total
Q.12
Promotional data include three main components: visits to office-based
practitioners and hospital specialists; free samples dispensed to physicians (their
12 This produces a price per standard unit. Note that our empirical specifications control for unobserved differences, such as quality and Defined Daily Dose (DDD), across molecules.
11
cost being estimated as the sales price of the drug); and advertising in professional
journals. IMS Health data on detailing are constructed using a representative panel
of physicians who track their contacts with sales representatives. The amount
spent on free samples is based on a panel of approximately 1200 office staff
members in medical practices, while expenditures on advertising in professional
journals are computed by tracking ads placed in approximately 400 medical
journals and then adding the publisher's charge for those ads.
The promotion level used in the demand specifications reported is computed with the perpetual inventory method, commonly used for physical capital, as follows
Ait = (1-) Ait-1 + Iit,
where Iit is the quarterly expenditure on promotion for drug i retrieved from IMS,
and is the quarterly depreciation rate, assumed to be 0.1 - i.e. about 35% per
year.
Table 1 reports descriptive statistics for these variables. Note that competitors'
promotion refers to the sum of the promotion of all other drugs in the ATC3
market, each computed according to the equation above. At the same time, the
competitors' price refers to the average price of all the other molecules in the
market, including generics, and it is computed as the ratio between total revenues
and total quantities in the ATC3 market, after subtracting the revenues and quantities of drug i.
3.2. Specification
We estimate the elasticity of a given molecule’s market share with respect to its
own price and promotion effort, as well as the corresponding cross-elasticities for
competing drugs. Our dependent variable is the quantity market share of a
particular molecule within an ATC3 market. Since our dataset contains many
molecules that have experienced LoE, we are in a position to estimate elasticities
Obs Mean S.D. Min Max
Market Shares of Molecule i 3870 0.139 0.183 0.001 0.982
Price of Molecule i 3870 19.410 73.571 0.023 618.870
Price of Competing Molecules in ATC3 3870 9.074 28.300 0.027 182.599
Price of Competing Generic Molecules 3870 3.500 10.456 0.015 102.456
Price of Competing Brand Molecules 3870 15.959 53.596 0.087 361.810
Promotion of Molecule i 3870 97899 208890 1 2021052
Promotion of Competing Molecules 3870 548659 953257 1 5739914
12
for a molecule depending on its status. Concretely, we can identify a molecule’s
competitors while it is on patent as well as when it goes off patent.
We assume that the market share of a molecule i at quarter t depends on own and
competitors’ price p and advertising a as follows:
= 1+2 + 3(1 − )− + 4− + 5(1 − )− + 6−
+ + + (1)
where sub-index –i refers to competitors in the market while E is an indicator
taking value 1 if (the LHS) molecule i at time t has lost patent protection and zero
otherwise. Accordingly, the coefficient 3 (respectively 5) measures the elasticity
with respect to competitors’ price (advertising) when there is only a brand version
of molecule i while the coefficient 4 (respectively 6) captures the cross-price
(advertising) elasticity when generic version of molecule i has already entered the market.
In specification (2), we distinguish between the price of brand (superscript B) competitors, − and the price of generic (superscript G) competitors, − . The
latter includes both branded drugs that are patent protected as well as originator
drugs that have lost exclusivity.
= 1+2 + 3(1 − )− + 4− + 3(1 − )− + 4−
+ 5(1 − )− + 6− + + + (2)
Both specifications (1) and (2) include a complete set of time dummies to
control for idiosyncratic shocks that are common across all molecules in the
market. The term captures persistent differences in market shares driven by
unobserved factors such as the quality of the sales force or the reputation of the
pharmaceutical companies marketing those drugs. Empirically, we control for
these persistent differences by estimating specifications (1) and (2) using fixed
effects.
To re-iterate, as long as a drug is patent protected, the dependent variable –the
molecule market share in the ATC3- is that of the branded (and patent protected)
drug. If the molecule experiences LoE during our sample window, then the
dependent variable is the molecule’s quantity market share within the ATC3,
which is made up of the original brand as well as any generic version. Hence, we
are able to identify a molecule’s competitors throughout its lifetime, as it moves from being a patent protected drug to a molecule experiencing generic entry.
The case of Prozac can serve as an illustration. The active ingredient in Prozac is
fluoxetine, and this branded drug experienced LoE during our sample window. In
this example, the dependent variable is the quantity market share of fluoxetine.
13
The latter coincides that of Prozac prior to LoE, while it is the combined market
share of Prozac, Teva fluoxetine, Barr fluoxetine etc., post LoE.
In (1), if the point estimate of 3 statistically differs from 4, then it is possible to
infer that the constraints exercised by i’s competitors evolves over molecule i’s
lifecycle. By analogy, the same interpretation applies in the case of specification
(2) where we distinguish between branded and generic competitors. Last, the
coefficients 5 and 6 allow us to gauge the importance of own and competitors’
promotional effort in the competitive process.
3.3. Results
We start with a preliminary thought exercise. Imagine a competition authority
seeking to identify market boundaries by evaluating own and cross-price
elasticities for a particular molecule. In the case of pharmaceutical products, we
have an important prior insight: we can readily identify the potential relevant
market by using the ATC classification. For the sake of this thought exercise, we
voluntarily omit the proprietary information promotion that is at our disposal.
This is to “reproduce” a hypothetical scenario whereby a competition authority has
detailed information on individual drug prices and quantities, but not on
promotion (or decides not to use promotion data). The last step in our thought
experiment involves the authority estimating cross price elasticities without
including promotion.13 The resulting estimates are presented in columns (1) and (2) of Table 2.
In column (1), we present the FE results without controlling for endogeneity. No
coefficient appears to be significant, potentially indicating substantial monopoly
power and no close substitute. We then instrument for prices in column (2),
following the standard approach to instrument prices with packages or prices set
by drug i manufacturer in other markets. This time, the own-price elasticity is
significant at the 5% level, but is of the wrong sign. Cross-price elasticities are
again insignificant, indicating that the molecule’s pricing is unconstrained by
competitors. The implementation of this thought experiment indicates that
demand estimation (and by association, market definition) that does not properly account for promotional effort suffers from a very serious omitted variable bias.
Columns (5) and (6) are the counterparts of (1) and (2) when we repeat this
thought experiment using specification (2). The results are just as inconsistent:
starting with the own price elasticity, the little that is significant is of the wrong sign.14
This illustrates the trappings ignoring non-price instruments when they are
important drivers of competition. As we show below, our detailed data allow us to
address these shortcomings. As a consequence, we are able to identify shifts in
13 This is akin to the empirical exercise carried out by the EU Commission in the context of the Pharmaceutical Sector Enquiry. See Glowicka et al. (2009), pp. 53-55. 14 In the Servier case, in recital #(2517) “the Commission considers that competition in promotion
should not be regarded as a source of significant competitive constraints from the specific perspective of the relationship between perindopril and its potential competitors”.
14
market boundaries that happen around the time of generic entry. These results
are of the same flavour as Sovinsky Goeree (2008) who shows that, in the context
of the US PC industry, not properly taking into account media exposure biases
price elasticities.
In columns (3) and (7) of Table 2, we present the FE results without controlling for
endogeneity problems for illustration purposes. The results of interest are those
appearing in columns (4) and (8), where we followed the standard approach to
instrument promotional effort with the number of packages (linear and squared)
and time to/from patent expiration. While own prices should be also considered
endogenous, the Hansen test of overidentifying restrictions is not passed when
variables such as packages or prices set by drug i manufacturer in other markets
(extensively used in the literature) are used to instrument prices. This is not
however a source of major concerns for the following reasons. First, when
instrumenting for price, the results are very similar to those reported in Table 3,
despite failing the Hansen test. Second, the test of exogeneity reported in the
bottom part of Table 2 suggests that prices can be treated exogenous for the
specifications we use. Last, Figure 1 indicates that, as compared to price, it is
promotion that is the strategic instrument of choice. The effect of competitors’
promotion is of the expected sign and highly significant, in all specifications. This
confirms the importance of properly accounting for non-price instrument.
Column (4) reports the own and cross price and advertising elasticities for
molecule i's market share before and after LoE. The estimates are of the right sign
and highly significant. Interestingly, we find that the cross-price and cross
advertising elasticities have similar magnitude before and after LoE.
To investigate whether patent expiration leads to changes in market boundaries, in
column (8), we study whether brand competitors and generic competitors exercise
the same competitive pressure on molecule i. We do so by splitting the price index
between an index of on patent competitors and a price only comprising drugs that
experienced LoE. The results in column (8) indicate that, prior to LoE, only brand
competitors exercise a competitive pressure on molecule i (coefficient 0.480).
Since this coefficient pertains to the period when the molecule is patent protected,
the dependent variable is the quantity market share of the brand. By contrast,
prior to LoE, generic competitors do not exercise a constraint (coefficient 0.058,
not significant). In other words, when a drug is on patent, it is only price
constrained by other on patent drugs. The price of genericised molecules in the
same therapeutic class do not exercise a constraint. Note that this implies that a
when a branded molecule experiences LoE, it stops exercising a constraint on its
patent protected former peers. In other words, the molecule experiencing LoE “drops out of the relevant antitrust market”.
Hence, these results suggest that the weak significance of the cross-price
elasticities reported in column (4) stems from the amalgamation of two
qualitatively different sources of competitive constraints in a single price index.
15
After LoE, we find that both brand competitors and generic competitors exercise
similar competitive pressure on molecule i (coefficient 0.388 and 0.315). This is
direct evidence of the existence of asymmetric competitive constraints: genericised
molecules do not constrain on-patent drugs, while the reverse applies. This
asymmetry is likely to stem from the promotional effort of on-patent drugs. In
Castanheira et. al. (2017), we provide a theoretical rationale for the fact that
following LoE, a drug stops being promoted (depicted in Figure 2 above). What we
deduce from the results reported in in Table 2 is that on-patent drugs that keep
being promoted exercise a twin constrain on genericised molecules, via price and
promotion. By contrast, the absence of promotion for genericised molecules
appears to neutralise the price constraint they would have been expected to
exercise on patent protected molecules (i.e., their former peers).
Table 2: Price and Advertising Elasticities before and after Lost of Exclusivity
Notes: Robust standard errors clustered at molecule level in parentheses. * signif. at 10% level; ** signif; at 5%; *** signif. at 1%. Endogenous variables: Own price in column (2) and (6) and own promotion in column (6) and (8). Instruments: #Packages (linear and squared), Time to/from patent expiration. a P-value for the Kleibergen-Paap rk statistics testing the null hypothesis that the model is under-identified. b P-value of C (GMM distance) test of endogeneity for own promotion and test of exogeneity for price. c Hansen J test of overidentifyfiing restrictions with degrees of freedom reported in parentheses.
Summing-up, these results suggest that there is indeed a change in market
boundaries in a relative short period of time, absent regulatory or technological
change. In particular, generic competitors seem to affect market shares of
molecule i only when the latter has become genericised. In addition, on patent
drugs are only constrained by their on-patent peers; “former” peers produced by a generic firm fade into insignificance.
(1) (2) (3) (4) (5) (6) (7) (8)
FE FE-IV FE FE-IV FE FE-IV FE FE-IV
own price -0.312 0.823*** -0.746** -1.102*** -0.498 1.131*** -0.788** -1.145***
(0.38) (0.22) (0.34) (0.31) (0.42) (0.34) (0.35) (0.31)
own advertising 0.535*** 1.078*** 0.539*** 1.127***
(0.08) (0.21) (0.08) (0.22)
(before molecule i's LoE) (0.17) (0.18) (0.14) (0.17)
competitors' price 0.093 -0.187 0.238 0.383**
(after molecule i's LoE) (0.17) (0.18) (0.15) (0.18)
competitors' advertising -0.189*** -0.413*** -0.192*** -0.431***
(before molecule i's LoE) (0.05) (0.11) (0.04) (0.11)
competitors' advertising -0.228*** -0.439*** -0.199*** -0.422***
(after molecule i's LoE) (0.06) (0.11) (0.04) (0.11)
brand competitors' price 0.255 -0.254 0.353** 0.480**
(before molecule i's LoE) (0.22) (0.25) (0.17) (0.19)
brand competitors' price -0.038 -0.014 0.196 0.388**
(after molecule i's LoE) (0.18) (0.24) (0.15) (0.19)
generic competitors' price 0.074 0.206** 0.063 0.058
(before molecule i's LoE) (0.07) (0.10) (0.06) (0.09)
generic competitors' price 0.358** -0.079 0.280** 0.315**
(after molecule i's LoE) (0.15) (0.16) (0.13) (0.14)
Obs 3870 3870 3870 3870 3870 3870 3870 3870
Underidentificationa <.0001 <.0001 <.0001 <.0001
Endog_Test b
Hansen_df 2 2 2 2
16
4 Competition
In the previous section, we reported results indicating that once a molecule
experiences LoE, it “drops out” of the antitrust market formed by on patent
molecules. Recall that in equation (1) and (2), the dependent variable is the
molecule’s market share within the ATC3. In that context, we obtained that, post
LoE, intermolecular competition is subdued: the cross-price elasticity between
genericised molecule is low (0.315).
Since it is well documented that post LoE, competition between generics is fierce, it
is natural to proceed further by identifying competitive interaction post LoE. This
will allow us to identify the competitive constraints faced by individual producers of genericized molecules.
To this end, we proceed by estimating the following equation:
= 1 + 2− + 3 + 5− + 4− + 5 + 6−
+ + + (3)
where and are the quantity market share and the price of a molecule i
produced by generic firm G at time t. The variables − refers to the price of
molecule i set by other generic companies and is the price of molecule i set by
the originator company (i.e. the company that produce the brand version of
molecule i). The variables − and − refer to the price of, respectively, other
generic molecules (that is, molecules that have lost patent protection before
molecule i) and other branded molecules (still covered by patent protection).
Finally, the specification includes the advertising effort made by the originator of
molecule i (for the few instances when they decide to go on advertising molecule i
after patent expiration) and the total advertising effort of other brand producers of
molecules still covered by patent protection.
To illustrate this specification for the case of antidepressants, would be the
price of Teva fluoxetine, − would be the average price of fluoxetine charged by
other generic producers of this molecule, such as Barr and Mylan, and would
be the price of the originator brand, Prozac (i.e. Lilly fluoxetine). Finally, − is
the price of other molecules whose patent expired before fluoxetine, while − is
the average price of other molecules that are still covered by patent protection
(e.g., sertraline sold by Merk under the brand name Zoloft). Hence, this
specification allows us to unearth the pattern of both inter and intra-molecular
competition post LoE.
Table 3 reports summary statistics for the variables used in specification (3).
17
Table 3: Summary statistics of Generic Producers
The results reported in Table 4 are obtained with a much larger sample. This is
because the unit of observations is no longer a molecule but a molecule and
generic producer pair. For instance, in our dataset, we observe more than 10
producers of fluoxetine. Moreover, while our dataset in Table 2 requires that a
molecule is covered by patent protection at the beginning of the sample period,
here we include all generic molecules, even those that start as generics since the beginning of our window.
Obs Mean S.D. Min Max
Firm Price of Molecule i 60136 1.086 8.605 0.001 452.174
Competitors' Price of Molecule i 60136 0.795 7.919 0.001 450.079
(other generic producers)
Originator Price of Molecule i 60136 2.086 17.864 0.001 371.177
(brand producer)
Price of Other Generic Molecules 60136 1.103 9.541 0.010 213.786
Price of Other Brand Molecules 60136 3.961 27.178 0.034 361.810
Promotion of Molecule i 60136 6846.7 37817 0 677264
Promotion of Other Molecules 60136 303743 796338 0 5839280
18
Table 4: Competition among Generic Producers
Notes: Robust standard errors clustered at molecule level in parentheses. * signif. at 10% level; ** signif; at 5%; *** signif. at 1%. Endogenous variables: Own price in column (2). Instruments: #Packages (linear and squared), Time to/from patent expiration, Number of generic producers of the same molecule. a P-value for the Kleibergen-Paap rk statistics testing the null hypothesis that the model is under-identified. b P-value of C (GMM distance) test of endogeneity for own promotion and test of exogeneity for price. c Hansen J test of overidentifyfiing restrictions with degrees of freedom reported in parentheses.
Once a molecule becomes generic, promotion drops to zero and price becomes the
central competitive variable. In that context, price clearly is endogenous. This is
reflected in our results that report a very significant increase in the size of the own
price elasticity once this regressor is properly instrumented. The own price
elasticity is highly significant and large (7.512), indicating that intramolecular
competition is close to a Bertrand outcome. This is consistent with the very large
cross price elasticity pertaining to producers of the same molecule (e.g. Barr
fluoxetine when Teva fluoxetine is the dependent variable).
The price of other genericised molecules within the same ATC3 has the right sign
but is not significant. This is in line with the results reported in the previous
section pertaining to subdued intermolecular competition post LoE. It would
appear that molecules that lose patent protection drop out of the patent protected
intermolecular market to land into an arena where what principally matters is intramolecular competition.
As in the previous set of results, we again observe a pattern of asymmetric
competition: the price and promotion of patent protected molecules do exercise a
(1) (2)
FE FE-IV
(same molecule) (0.05) (0.92)
(same molecule) (0.06) (0.26)
(other molecules) (0.06) (0.24)
(other molecules) (0.08) (0.33)
(same molecule) (0.02) (0.08)
(0.01) (0.10)
significant constraint on genericised molecules. Summing up, generic versions are
between “a rock and a hard place”: they face fierce competition from other generic
producers of the same molecule, and the overall share of this genericised molecule
is capped by promotion of on-patent molecules. This explains why, despite
significantly lower prices, the total quantity market share of the genericised
molecule falls (cf. Figure 2). In Castanheira et. al. (2017), we provide a theoretical
rationale for this phenomenon.
Last, the coefficient of promotion for the originator’s brand has a positive sign and
is significant. In our example, this would the promotion for Prozac when the
dependent variable is Teva fluoxetine or Barr fluoxetine. Since this variable is
measured as a depreciating stock, it still takes positive values post LoE, even if the
flow of promotion drops dramatically before LoE (cf. Figure). At first sight, the
positive sign could appear as counterintuitive. However, what it reflects is the
well-known result that promotional effort is not attractive in the context of
homogeneous goods: own promotion benefits competitors. In the context of our
estimation past promotion for Prozac benefits generic producers of fluoxetine.
5. Conclusion
In this paper, we have shown that, in the pharmaceutical industry, antitrust market
boundaries can change fast. We highlight that within the definition of markets
based on the ATC3 level of aggregation often as starting point by competition
authorities, there are sub-markets in which the conditions of competition differ
substantially. Importantly, the composition of these sub-markets evolves over
time, with products “hoping” from one market to another.
Our results show that when a drug is on patent, it is only price constrained by
other on patent drugs. The price of genericised molecules in the same therapeutic
class do not exercise a constraint. This implies that a when a branded molecule
experiences LoE, it stops exercising a constraint on its patent protected former
peers, thus effectively dropping out of the relevant antitrust market.
We show that molecules that lose patent protection drop out of the patent
protected intermolecular market to land into an arena where what principally
matters is intramolecular competition. In addition, we find that promotional effort
is a key driver of competitive interaction. Our empirical results clearly indicate that ignoring this variable can lead to flawed conclusions.
We advocate that these findings have profound implications for competition policy
in jurisdictions that put a heavy weight on market definition. More precisely, it is
not because a genericised drug does not compete with on patent peers that it did
not form part of the same antitrust market in the (very) recent past. By the same
token, it is not because a drug competed in the (very) recent past with other drugs
that it does so today. With the possible exception of post LoE intramolecular
competition setting, ignoring promotional effort is bound to lead to serious
mistakes in market delineation.
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25
Appendix: computation, use (and misuse) of market shares
In the presence of product differentiation, be it vertical, horizontal (or both),
market definition can be complex. Second, a market share, however precisely it is
measured, is not a direct measure of market power. This is because the
relationship between market share and market power is likely to be non-linear
and non-monotonic (Neven, Nuttal and Seabright, 1993).
Despite its intrinsic limits, a market share criterion to approximate the extent of
market has some desirable properties. First, it is underpinned by theory, albeit in
a loose manner. Second, it is relatively easy to compute. Third, it offers legal
certainty to undertakings. Fourth, and linked to the previous point, it can be useful
screen to avoid pursuing abuse cases against firms that could not possibly enjoy a
significant degree of market power.
However, too much adherence to a particular market definition is not warranted in
a number of circumstances. First, the starting point may matter: imagine three
single firm products, A, B, C. Firm producing B may be constrained by both A & C,
while C may only be constrained by B. Second, new products, or quality upgrades,
may alter the competitive landscape. For instance, the emergence of a product D
may put pressure on C, but barely affect A. Concrete examples include the
emergence of e-publishing for books and newspapers, or new transport modes
between two points (e.g. high speed rail connections between two cities that were
connected by air).