Economics of the Pharmaceutical Industry Thesis

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Economics of the Pharmaceutical Industry

The pharmaceutical industry is highly complex and segmented. The costs for bringing a new product idea to the market are high. It is a long process that is heavily influenced by government regulation, the need for patent protection, and the risks associated with failure. The failure rate is high, making this one of the most volatile industries in the world. In order to survive and thrive, many companies have resulted to vertical integration as the key to survival. This model has benefits for both the larger acquiring company and for the smaller company in terms of survival.

The Economics of the Pharmaceutical Industry

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The pharmaceutical industry is the heart of the healthcare system. Pharmaceuticals are necessary, sometimes as necessary as food and water when the condition is life threatening. Some people cannot live without these life-giving chemical concoctions. However, from a financial perspective, the pharmaceutical industry is one of the most volatile. One of the key difficulties that they face is the costs of research and development, the long time period before products make it to the marketplace and the influences of health insurance agencies and government regulators. The pharmaceutical industry is complex because it involves more than simply the producer and the end consumer. The ability of the pharmaceutical industry to make profit depends in the interactions of many outside influences. This research will explore the economics of the pharmaceutical industry. It will support the hypothesis that in order to improve profit margins, vertical integration is the key.

Overview of the Pharmaceutical Industry

Thesis on Economics of the Pharmaceutical Industry Assignment

The pharmaceutical industry differs from other sectors of the market in many ways. Capital expenditure and return on investment is the key area where this industry differs from others. In other industries, companies invest capital, quickly bring a product to market and begin realizing a return. The return on investment is typically short when compared to the pharmaceutical industry. In the pharmaceutical industry, the return on investment is typically long-term, possibly even a decade if at all.

Researchers must attempt to convince investors of their theory and the potential that their research has to offer. They must demonstrate a need and a significant market base. Then they begin the long process of research and development. When the area is new, such as it was in the beginning of human genetics research, the time to bring an actual product to the market can be quite long due to the amount of preliminary research that needs to be completed before product research can begin. Once product development begins, there are any number of factors that can go wrong to slow the process, or halt it altogether.

The process for bringing a product to market must undergo a tedious process that is established by the Food and Drug Administration. This process includes extensive testing on animals long before the new product can be tested on humans. The product must first test safety tests and then efficacy tests before coming to market. Often use of the product is limited to only patients that resemble the test population. At any time in the process, or at any time after the product came to market, a safety recall can occur and the product will no longer represent a tangible asset to the company.

The process of developing drugs and bringing them to market is referred to as the "pipeline." This term refers to the process of pharmaceutical product development from concept to market. Successful pharmaceutical companies often have multiple products along various phases of the product pipeline. They cannot rely on only one product. If something happens and the product is pulled by the FDA, the company has little chance for financial recovery. Risk management in the pharmaceutical industry means continual innovation and seeking new avenues for product development. The successful company relies on continually beginning new products and bringing them to market. New product development often stems from either doing something that has never been done before or doing something better that it is currently being done.

The key to success in the pharmaceutical industry is controlling the enormous costs associated with bringing products to the market. In addition to these astronomical costs and long time until they can achieve a return on investment, pharmaceutical companies are limited in their ability to raise prices to increase their profits. Insurance companies, healthcare providers, and government regulations place caps on the prices that pharmaceutical companies can charge. This limits their ability to recover investment capital and to increase their profit margins. In order to cope with these challenges, pharmaceutical companies often must take drastic measures to improve their economic stance. For many this means that mergers and acquisitions abound. The following will examine these issues in greater detail in order to support the hypothesis and to gain a better understanding of the pharmaceutical industry.

Industry Structure

The pharmaceutical industry is unique in many ways. One of the key distinguishing characteristics is that consumer cannot obtain certain products unless they present a prescription from a licensed physician (Scherer, 2000). The purchase decision is controlled by the physician, who has no responsibility for paying for the cost of the medication in most circumstances. The market is divided on into two primary segments, on a macro level. The market is divided into prescription and over the counter products. Both of these categories represent different markets altogether. The over the counter segment of the market operates much like many of the product markets. The consumer makes the final purchase decision independently and pays for the product directly, much like any other product in the retail sector. The prescription segment of the market is the most complex. To make matters even more complex, certain drugs begin their life as prescription medication and then are allowed to shift into the over the counter segment of the market.

The demand-side of the market must interact with a monopolistic supply side. Monopolies on the supply side serve to support prices, allowing the drug companies to achieve a substantial margin. Nearly 640 pharmaceutical companies exist in the United States. Many of the top manufacturers in the U.S. are multinational enterprises (Scherer, 2000). In developed nations, exports account for a little less than 10% of the market, but in developed nations, exports account for as much as 20% of the nation's drug supply (Scherer, 2000).

As competition becomes tougher, vertical integration becomes a key to survival (Scherer, 2000). During the 1990s, aggressive vertical integration resulted in only four top companies accounting for 80% of the U.S. wholesale pharmaceutical producers (Scherer, 2000). In addition to outright buyouts, many of the manufacturers decided to pool their research and development activities in order to save costs (Scherer, 2000). Strategic alliances are now the norm in the pharmaceutical industry.

Outsourcing is becoming another popular alternative to mergers and acquisitions. Outsourcing has been found to decrease the time from discovery to market (Coulson & Kleiner, 2008). The outsourcing of pharmaceutical activities to other countries has raised concerns over security, privacy, and human rights issues in the industry (Aruru & Salmon, 2008). Concerns over counterfeit, substandard drugs are also affecting the current state of the pharmaceutical market. Concerns over these counterfeits and potential dangers associated with them has increased the need for the trust associated with brand names (Yankus, 2008).

The pharmaceutical industry is highly specialized. Many of the products that are developed are designed for the treatment of only one specific disease or condition. It was found that the costs of treating psychosis are the highest among all of the sectors (Garis & Farmer, 2002). There are few drugs or categories of drugs that are widely used in a variety of conditions. Therefore, vertical integration is one of the few ways to achieve a market of scale. Many companies have chosen to specialize within a certain area. For instance, the company may specialize in the treatment of cancers, or in heart conditions. They acquire only companies that operate within the specific field of specialty. There are few companies that could be said to have a monopoly over the entire pharmaceutical industry, but there are a few that have a monopoly within a certain specialty or field within the industry.

Impact of Government Regulation

It was recognized that just as pharmaceutical products could be beneficial; the potential also existed for them to do considerable harm as well. Consistency and effectiveness is another key issue in the pharmaceutical industry. Many drugs only have one or two active ingredients. These ingredients only work if they are administered in specific dosages. In addition, an overdose of many compounds could prove harmful or even fatal in some cases. In order to protect the consumer and to assure quality in the pharmaceutical profession, the Pure Food and Drug Act of 1906 was introduced (Scherer, 2000). This act regulates any substance that is used on or put in the human body to make certain that it meets certain safety standards and that it performs as claimed. This act plays an… [END OF PREVIEW] . . . READ MORE

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How to Cite "Economics of the Pharmaceutical Industry" Thesis in a Bibliography:

APA Style

Economics of the Pharmaceutical Industry.  (2009, December 15).  Retrieved July 15, 2020, from

MLA Format

"Economics of the Pharmaceutical Industry."  15 December 2009.  Web.  15 July 2020. <>.

Chicago Style

"Economics of the Pharmaceutical Industry."  December 15, 2009.  Accessed July 15, 2020.