The pharmaceutical industry

The Pharmaceutical Sector and Research & Development

The pharmaceutical sector is important because it is at the forefront of medical innovation. The research-based industry in the United States invests around 17% of its sales in research and development. The drivers of the performance of the individual firm as well as the industrial structure are research and development. Pharmaceutical is a highly regulated business since pharmaceuticals’ safety, efficacy, and quality must be constantly evaluated. Furthermore, promotional communications must adhere to the product’s permitted qualities. A variety of factors influence the pharmaceutical industry’s economics, including drug price regulation and growing markets. Research and development are a powerful force that affects the access of the available market since it regulates products characteristics and promotion. Of late, small companies manufacture new drugs that out-license their products to bigger firms who only concentrate on the later stages of drugs developments and commercialization. However, the pharmaceutical industry is rapidly changing because small and well-established companies have to share responsibilities and rewards within the existing and emerging markets. The aim of this paper is to assess the various economic issues relating to the performance and structure of research and development such as price regulations, emerging markets, and utilization of drugs.

Economic Factors Affecting the Pharmaceutical Industry

Regulation of promotion and market access originates from insecurity about drug efficacy and safety. The pharmaceutical industry is a large environment controlled by more than just the firm owners as whatever they do must adhere to the powers of the FDA, market demands, and economic factors. Some of the economic factors that influence the industry include gross domestic product, exchange rates, and interest rates. Pharmaceutical companies are more of research and development intensive, and hence they rely on financial markets to fund their operations and capital investment efforts. However, this is not the case with some of the small firms as they finance their expenses from their internally generated cash.

High inflation rates within the country

High inflation rates within the country force central banks to raise their interest rates. In turn, this leads to higher costs of borrowing for the drug companies and thus causing reduced capital and research and development investments. When the economic growth is weak, investing in the pharmaceutical industry becomes risky as well, and this forces investors to flee to safety as not many people will seek medical help, especially if they are costly. Private investors prefer less risk and more stable business in times of weak economic growth. A better example is when the financial crisis of 2009 caused a drop in pharmaceutical investment by 19%. In cases of limited available capital, drug companies are forced to offer high return rates to acquire funding (Kruse et al., 2014).

Impact on hospitals and healthcare system

Despite the fact that the demand for drugs barely changes within these economic cycles, it hinders the hospitals and healthcare system from buying expensive biologic drugs or even buying drugs in bulk. As the rates of unemployment increases, while tax revenues decline, there is public pressure to reduce the spending of health care. As a result, pharmaceutical firms have no choice but offer the products on higher discounts, which ultimately affect their profit margins. Interest, inflation and GDP rates, therefore, affect the ability of investors to invest in a firm and as long as there is no investment, the research and development programs are affected limiting the performance of the pharmaceutical industries.

Existing Emerging Markets

Emerging markets signify a brilliant opportunity for the pharmaceutical industry. Even though there is no precise definition, economists identify emerging markets as developing prosperous nations that investment is predicted to result in higher rates of income irrespective of the high risks. For a market to qualify as emerging in not just based on the country’s economic status, but it depends on numerous other criteria that render a state to earn such a definition (Danzon, 2016). Some of the existing promising markets include Russia, India, Brazil, South Africa, China, Mexico, Turkey, South Korea and Indonesia. The shift towards these up-and-coming markets is mainly attributed to the large populations, increased life expectancy, and growing prosperity (Tannoury & Attieh, 2017). Besides, many firms expect a flattened growth in the developed countries, expiration of patents causing up-selling of generic drugs that are less expensive and rigid regulations set to govern the mature markets. Particular attention must thus be given to the new market that offers potential financial growth to the drug industries. The strategies used by the pharmaceutical companies that seek to expand to these new horizons must be tailored to much the pace of these developing markets. The mentioned countries demand drugs against infectious and communicable illnesses, for example, sexually transmitted diseases. These emerging markets are readily exploitable regions especially for new and innovative products of the pharmaceutical firms.

Challenges in Emerging Markets

However, conquering these emerging markets can prove to be challenging regarding research and development for the companies and these challenges can be grouped into three categories: value-driven drug evaluation, development of infrastructure and policies relating to cost-containment.

Trends Influencing Pharmaceutical Growth: The Paradigm Shift

Pharmaceutical industries are rapidly growing in the emerging markets, and this can be owed to various factors. The first factor relates to the patent cliff that affects several branded drugs that have been present for ages. The second is the current shift towards the use of generic medicines in both developed and developing nations. The third one is the alteration in disease patterns, particularly in the emerging countries. Finally, the current difference between the manufacturing cost and market prices as experienced within the research and development process.

Branded Drugs in Emerging Markets

Emerging countries are promising markets for branded drugs that have been selling for ages. This thus boosts the opportunity for success when launching new medicines customized particularly for these markets. Such position products will increase the profits of the firms undoubtedly. With the increased globalization, drug companies continue to establish distinct footprints with medications that can cater to all populations (Baena, 2012). The emerging markets are not only good for investing, but also the presence of human capital, increasing income and low-cost wages in these nations make them viable locations for sourcing. Costs of production, research and development are constantly on the rise in these markets. Studies reveal that performing research and development in these countries are less costly and can diminish the costs of selling the drugs significantly, thus enabling the pharmaceutical industries to lower their prices and maintain high profits (Bhanji, 2012). Growth in the emerging countries accompanied by wealth and prosperity encourages spending on unhealthy lifestyles such as indulging in fast food eating and consumption of narcotics and this is increasing at a rapid pace; in the end, this creates a potential economic growth for the pharmaceutical industry.

Patented Pharmaceutical Market

It is the prices that regulate both the needs and desires of the customers along with the costs and risks that manufacturers must incur while creating merchandise. More precisely, the market price for a product is agreed on by the cost of production coupled with the marginal value buyers attribute to the goods. In various markets, this is easily achieved because these markets lack high fixed costs. They also require processes of production that take a long time to accomplish, they have little regulatory costs, and they do not need large amounts of research and development before producing the products.

Challenges for Innovator Companies

Efficient pricing of drugs is highly complicated than normal markets; sometimes it is because it is not the patients who pay for the majority of costs incurred during research and development. For example, the private sector today only pays for less than a half of the $2.6 trillion allocated for health care, and this constitutes about 17.8% of the GDP; this is slightly higher than $1 in every $10 which is funded by the patients by their expenditure (Herper, 2016). Based on low production costs, pharmaceutical companies developing innovative drugs continue to face potential competition from businesses that do not spend significant amounts of money in research and development. Without recovering the research and development costs, prospective competitors have the ability to manufacture a generic drug, get on the market and sell a generic copy of the new drug at a lower price. The original companies cannot match such low prices while at the same time recovering the costs of research and development. In the end, such practices threaten the existence of the innovator companies.

Pricing in Healthcare Market

Irrespective of the challenges inherent in the pharmaceutical industry, fundamental market forces still are present in the market. Drug manufacturers take on intense competition against each other, just like companies in other industries as well, to find sufficient investment that will fund their efforts in research and development. Investors will only be willing to invest in a company if they are sure that the returns will be huge, and this entails compensation for the high risk connected with the pharmaceutical industry. The companies earn profits by negotiating prices with the buyers who negotiate on behalf of the patients. The paid prices often reflect the balance between costs of pharmaceutical manufacturers, benefits that the patients gain, and medication gains from alternative therapies.

The prices incurred by innovator drug companies include costs in production, research, and development; the costs that potential manufacturers who do not develop the drugs, are found in the cost of research and development spent by the innovating companies (Dimasi et al., 2010). Therefore, a non-innovator pharmaceutical company in need to compete with an innovator corporation must sell the new drugs at production’s marginal cost to earn a competitive return. In most cases, the innovators find it difficult to compete at these minimum prices. The set market price to lure healthcare providers is never high enough to offer an adequate return on the investment, and this threatens not only the availability of original drugs but the companies as well.

Price Regulation - Rationale and Effects

The fact that there is a great entry in the pharmaceutical industry illustrates how it is structurally competitive. There is market power derived from patents, which are legal grants encouraging the practice of monopoly so that innovator firms can recoup their research and development costs (Kruse et al., 2014). However, this still does not hinder small companies from gaining entry into the market. Hence, neither patents nor monopoly offers a rationale perspective of controlling the pharmaceutical prices. The logic of regulating the drug prices originate from third party payments or insurance that makes the patients less sensitive to prices, thereby offering incentives to suppliers for charging higher prices (Santerre, 2011). The fact that a company can quickly launch an approved product without first have a price approval confirms that regulation of drug prices is best approached as a response to insurance. Depending on the features entailed in the price regulatory system, it may influence the drug availability, prices, production factors, utilization as well as the level of research and development.

Conclusion

Research and development play a significant role in fostering the structure of economic of the pharmaceutical industry. As seen in the paper, a revolution in the pharmaceutical industry has altered the nature of drug production as well as the perspective of facing the available market. Most of the developed countries have highly been exploited and offer little chance of return. Thus, most drug companies now look to the horizon filled with emerging markets. However, this is not lucrative as there is a high entrance rate of non-innovator firms that produce generic drugs sold at marginal prices, which threaten not only the levels of research and development but the existence of the originator companies who cannot earn adequate returns. In conclusion, the economics of the pharmaceutical industry is sensitive as it affected by various social and economic factors that are indecisive to regulate. The existence of many companies is threatened by such forces that encourage competition while new start-ups threaten the efficacy of the market and utilization of drugs.

References

Baena, V. (2012). Market conditions driving international franchising in emerging markets. International Journal of Emerging Markets, 7(1), 49-71. doi:10.1108/17468801211197879

Danzon, P. M. (2016, Fall). Economics of the Pharmaceutical Industry. Retrieved June 24, 2017, from http://www.nber.org/reporter/fall06/danzon.html

Dimasi, J. A., Feldman, L., Seckler, A., & Wilson, A. (2010). Trends in Risks Associated With New Drug Development: Success Rates for Investigational Drugs. Clinical Pharmacology & Therapeutics, 87(3), 272-277. doi:10.1038/clpt.2009.295

Herper, M. (2016, March 24). The Cost Of Creating A New Drug Now $5 Billion, Pushing Big Pharma To Change. Retrieved June 25, 2017, from http://www.forbes.com/sites/matthewherper/2013/08/11/how-the-staggering-cost-of-inventing-new-drugs-is-shaping-the-future-of-medicine/

Kruse, S., Slomiany, M., Bitar, R., Jeffers, S., & Hassan, M. (2014). Pharmaceutical R&D Productivity: The Role of Alliance. Journal of Commercial Biotechnology, 20(2). doi:10.5912/jcb632

Price Discrimination in Pharmaceutical Companies: The Method to the “Madness”. (2012, April 2). Retrieved June 24, 2017, from https://www.hcs.harvard.edu/hghr/online/price-discrimination-method/

Santerre, R. E. (2011). National and International Tests of the New Drug Cost Offset Theory. Southern Economic Journal, 77(4), 1033-1043. doi:10.4284/0038-4038-77.4.1033

Tannoury, M., & Attieh, Z. (2017). The Influence of Emerging Markets on the Pharmaceutical Industry. Current Therapeutic Research. doi:10.1016/j.curtheres.2017.04.005