Competition in the pharmaceutical industry: How do quality differences shape advertising strategies?

• Published in: Journal of health economics 2013-01, Vol.32 (1), p.268-285
• Main Authors: de Frutos, Maria-Angeles, Ornaghi, Carmine, Siotis, Georges
• Format: Article
• Language: English
• Subjects: Advertising; Advertising as Topic - economics; Advertising as Topic - methods; Brand loyalty; Competition; Drug Industry - economics; Drug Industry - methods; Drug Industry - organization & administration; Economic Competition - economics; Economic Competition - organization & administration; Economic models; Economic rent; Health administration; Humans; Market segmentation; Models, Economic; Pharmaceutical industry; Pharmaceutical Preparations - economics; Pharmaceutical Preparations - standards; Pricing; Product differentiation; Qualitative analysis; Studies
• ISSN: 0167-6296; 1879-1646
• DOI: 10.1016/j.jhealeco.2012.07.006

We present a Hotelling model of price and advertising competition between prescription drugs that differ in quality/side effects. Promotional effort results in the endogenous formation of two consumer groups: brand loyal and non-brand loyal ones. We show that advertising intensities are strategic substitutes, with the better quality drugs being the ones that are most advertised. This positive association stems from the higher rents that firms can extract from consumers whose brand loyalty is endogenously determined by promotional effort. The model's main results on advertising and pricing strategies are taken to the data. The latter consists of product level data on prices and quantities, product level advertising data, as well as the qualitative information on drug quality contained in the Orange Book compiled by the Food and Drug Administration (FDA). The empirical results provide strong support to the model's predictions.