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

Posted: 21 Jul 2016

See all articles by Maria Angeles de Frutos

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: July 25, 2012

Abstract

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.

Keywords: Product differentiation, Market segmentation, Advertising, Pharmaceutical industry

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? (July 25, 2012). Journal of Health Economics, Vol. 32, 2013, Available at SSRN: https://ssrn.com/abstract=2812124

Maria Angeles De Frutos

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 (Contact Author)

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 )

London
United Kingdom

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