Competition, Information, and Prices

What is asymmetric competition?

Photo: Miguel Vieira. Source: Wikipedia

Asymmetric competition is when companies are rivals but have different bases to compete from. For example, Jaguar may compete with Mercedes in the luxury auto market, but if there are no dealers that sell Jags within 100 miles of where you live, can you really say that consumers have a choice? They may be rivals, but you can’t really say that they’re competitors.

The same thing happens with pharmaceuticals. A big drug company develops and markets a treatment, and they typically have a patent on that treatment for 20 years. When the patent expires, other companies can produce and sell the same molecule under a different name. For example, when Eli Lilly’s patent for Prozac expired in 2001, generic drug companies could market the underlying chemical, fluoxetine, as Sarafem or Selfemra or something else.

Generic Prozac. Source: Wikipedia

Generic competition is supposed to make treatments safe and affordable. The US has even enshrined it into law with the 1984 Hatch-Waxman Act, which makes it easy for companies to get regulatory approval for established drugs. This should encourage price competition and limit Big Pharma’s ability to maintain high prices. But prescription drug spending keeps growing, rising by double digits in some years, despite many drugs coming off patent.

One factor to consider is that drug companies don’t just compete on the basis of price. They also promote their drugs. In some cases, the drug companies spend up to 15% of total sales to encourage prescriptions. When the patent expires, the price comes down and the promotions stop. Other, related drugs still get promoted, however. So when Lilly’s Prozac went off patent, their competitor Pfizer still encouraged sales of its alternative anti-depressant, Zoloft. After patent expiration, a drug’s price typically falls by 50%, but total sales of that drug and its generic equivalent also fall – by 25% or more.

Drug Price (P) and Quantity (Q) before and after patent expiration.

Source: VoxEU

This makes sense. You can’t buy something that you don’t know about, and firms promote products that have the best profit potential. If a drug is about to come off patent, the return on promotional spending is lower, and that spending slows. People then stop using the drug because they’re not as informed.

One common assumption in many economic analyses is that consumers possess perfect information. But this is never true. Information has a cost, and getting timely information into the right hands isn’t that easy. Limiting promotional spending hardly seems the solution. Rather, finding better ways to tell people what their options are – and how much they cost – seems more likely to succeed.

Price competition is an important aspect of any market. But you also have to consider who the players are – and how much they know. Especially when drugs are involved.

Douglas R. Tengdin, CFA

By | 2017-07-17T12:21:28+00:00 March 2nd, 2017|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. –
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