Competition in the Pharmaceutical Industry: How Do Quality Differences Shape Advertising Strategies?

39 Pages Posted: 22 Nov 2010  

Maria Angeles de Frutos

Universidad Carlos III de Madrid - Department of Economics

Carmine Ornaghi

University of Southampton - Division of Economics

Georges Siotis

Universidad Carlos III de Madrid - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: October 2010

Abstract

We present a Hotelling model of price and advertising competition between prescription drugs that differ in quality/side effects. Advertising results in the endogenous formation of two consumer groups: brand loyal and non-brand loyal ones. We show that advertising strategies 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 principal hypotheses on advertising and pricing strategies are taken to the data. The latter consists of product level data on price 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.

Keywords: advertising, market segmentation, pharmaceutical industry, Product differentiation

JEL Classification: I11, L11, L13, L65, M37

Suggested Citation

de Frutos, Maria Angeles and Ornaghi, Carmine and Siotis, Georges, Competition in the Pharmaceutical Industry: How Do Quality Differences Shape Advertising Strategies? (October 2010). CEPR Discussion Paper No. DP8076. Available at SSRN: https://ssrn.com/abstract=1711089

Maria Angeles De Frutos (Contact Author)

Universidad Carlos III de Madrid - Department of Economics ( email )

Calle Madrid 126
Getafe, 28903
Spain

Carmine Ornaghi

University of Southampton - Division of Economics ( email )

Southampton, SO17 1BJ
United Kingdom

Georges Siotis

Universidad Carlos III de Madrid - Department of Economics ( email )

Calle Madrid 126
Getafe, 28903
Spain
+34 91 624 9312 (Phone)
+34 91 624 9875 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Paper statistics

Downloads
2
Abstract Views
373