Pharmaceuticals Regulation

Why does generic entry increase competitor brand’s market share?

Consider the case of two drugs, Drug A and Drug B. Both drugs treat patients with the same disease. Further, assume they are close substitutes. When Drug A loses it’s patent and generics can enter the market, one would expect Drug A’s market share (brand + generic) to rise. In fact, Drug A’s market share often falls. Why is this the case?

To answer this question, Castanheira, Ornaghi and Siotis (2019) create a model motivate why this may be the case. Their model predicts that:

First, generic competition for A allows B to increase its price and its market share when the two products are close substitutes…The rationale is that the more substitutable the two goods are, the more aggressively A and B compete prior to generic entry, in phase 1. This translates into initially lower prices and higher promotion. In that situation, generic entry has a comparatively small impact on prices: the reduction in promotion dominates. High levels of differentiation have the opposite effect: prices are initially high and promotion low. Then, generic entry primarily affects prices: both A’s and B’s prices drop.

Second, B benefits from A’s loss of exclusivity when the market is large and profitable. The reason is that these are the markets in which firms initially invest the most in promotion and detailing. Then again, profit erosion on the A-segment after generic entry triggers a large drop in promotion intensity for A, which eases competitive pressure on B. Hence, the prediction of the model is that generic competition significantly curtails B’s market share only in small and comparatively less profitable markets.

A key question is whether this prediction works empirically. It turns out that the answer is ‘yes’. The authors use drug price, sales and promotion expenditure from IMS Health and loss of exclusivity data from the FDA for drugs between 1994 and 2003. However, a simple regression-based approach is problematic due to reverse causality. For instance, market share may shift in anticipation of market share shocks. Second, prices are measured inaccurately as they do not account for rebates.

To address these issues, the authors use two instrumental variables approaches. The first follows Chaudhari et al. (2006) and uses the number of different packages (linear and squared) since new packages or modes of administration is likely correlated with promotional efforts but not market share. The second set of instruments follows Dubois and Lasio (2017) and uses regression residuals from regressions of UK prices over molecule dummies and time fixed effects to instrument for the corresponding US drug channels. Using these approaches, the authors find that:

…despite price drops as high as 45% for the drug experiencing generic entry, the average effect is to boost the market share of competing molecules. Thevolume market share of the molecule that is now cheaper—the originator drug plus its chemically equivalent generic version—drops by 31%in the pharmacy channel and by 26% for drugs sold in hospitals.

In recent years, however, health insurers have started increasing copayments for branded drugs when generics are available. It would be interesting to see if these findings continue with more recent data.


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