Program on the Pharmaceutical Industry (POPI) Working Papers

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POPI WP #64-03
An Economic Framework for Evaluating Personalized Medicine
Sarah C. Stallings, Whitney P. Witt, William H. Crown, et al.
August 2003
Pharmacogenomics and personalized medicine promise to improve health care for chronically ill patients by increasing drug effectiveness and minimizing side effects of drug therapy. There may also be substantial savings realized by eliminating costs associated with failed treatment. Since these issues are not adequately explored across disease areas, the overall economic impact of personalized medicine remains uncertain. Using asthma as illustration, this paper describes a new framework for analyzing the potential value of using a pharmacogenomic diagnostic test in clinical practice.

POPI WP #63-02
Entry in Pharmaceutical Markets
Margaret K. Kyle
January 2002
The diffusion rate for new, patented technologies depends on the strategies implemented by innovators for entry into market segments. This paper examines the determinants of such entry, employing an international panel dataset on the pharmaceutical industry. A range of econometric models for a firm’s decision to launch a new pharmaceutical product in 21 OECD countries is estimated, with five main results. First, the likelihood of entry is increasing in the population of a country, but at a decreasing rate, and products are less likely to be launched in countries that regulate drug prices. Second, competition matters: one additional drug in a market reduces the probability of another’s entry by about 30%. Third, firm characteristics have a substantial impact on entry. The advantage to being a domestic firm is particularly strong. Fourth, drugs that compete in multiple therapeutic classes, that have been recently developed, and that are widely referenced in the scientific literature are more likely to enter a market. Finally, country-specific effects remain. Certain firm and product characteristics have greater salience in some countries than in others, and the effect of competition also differs. The results suggest that the interaction between the innovating firm, drug, and target country is a critical component of profitability, and that regulations may not affect firms and products uniformly. In other words, even in an industry with the potential for ubiquitous licensing, the specific match quality between the innovating firm and idiosyncratic market conditions remains an important determinant of entry.

POPI WP #62-01
The Many Faces of Outsourcing: Adjustment Costs, Transaction Costs, and Governance Spillovers
Pierre Azoulay
October 2001
Since the mid-1980’s, pharmaceutical firms have partly contracted out the operational aspects of clinical trials to Contract Research Organizations (CROs). Using detailed project-level data complemented by in-depth interviews at six pharmaceutical and biotechnology firms, I document patterns consistent with two existing theories of outsourcing. In accordance with neoclassical theories of adjustment costs, outsourcing intensity is sensitive to surprises in the demand for clinical trial services. In accordance with the predictions of transaction-costs economics, knowledge-intensive projects are more likely to be assigned to internal teams, while data-intensive projects are more likely to be outsourced. In addition, a project of a given degree of complexity is more likely to be outsourced when the firm’s overall portfolio is more skewed towards knowledge-intensive projects. Combined with qualitative evidence suggesting the potential importance of performance spillovers across projects, this last econometric result draws attention to the perils of taking a single transaction as the unit of analysis when explaining shifts in firm boundaries. The paper thereby provides a first step towards a “portfolio approach” to transaction-costs economics.

POPI WP #61-01
Do Pharmaceutical Sales Respond to Scientific Evidence? Evidence from Anti-ucler Drugs
Pierre Azoulay
September 2001
I investigate how difference sources of information influence the diffusion of pharmaceutical innovations. In prescription-drug markets, both advertising and scientific information stemming from clinical trials can affect physicians’ prescription choices. Using novel indices of clinical-research output, I find that both marketing and scientific evidence directly influence the diffusion process in the anti-ulcer drug market, with marketing having a more pronounced impact. I also find evidence that clinical outputs are important drivers of firms’ marketing efforts, affecting sales indirectly. Taken together, the direct and indirect effect of science on demand imply strong private incentives for clinical research. I conclude that product-market competition in the pharmaceutical industry is shaped both by advertising rivalries and scientific rivalries. Moreover, drug advertising may perform an important informative function.

POPI WP #60-01
Active Learning from Process Data
G. K. Raju & Charles L. Cooney
June 2001
Much of the prevailing connectionist machine learning research in chemical engineering assumes a one-way passive relationship between the learner and the application domain. In this paper, we investigate a two-way active relationship between learner and domain. We argue that this is useful and even necessary if the prevailing research is to be successfully applied to real world problems involving sparse and strongly biased data. A process development case study is used to illustrate the impact of data quality and quantity and to compare the performance of active learning against conventional passive learning. In doing so, we highlight the need to assess data quality and demonstrate the improvement in the rate of learning that results from active learning.

POPI WP #59-01
Technological Innovation in Pharmaceuticals
Sarah C. Stallings, Robert H. Rubin, Thomas J. Allen, et al.
May 2001
Scientific and technological advances have led to many important innovations in drug discovery and development. Some have allowed rapid gene sequencing consequently making genetic information about cellular mechanisms of disease available at an unprecedented rate. Others are allowing access to increasingly sophisticated data on the disposition of that genetic information. We have analyzed how several of these advances have been integrated into the process of drug discovery and development. Our studies suggest that 1) technological advances are rooted in basic research that may take years to mature into effective strategies for developing new therapies, 2) new technologies are facilitating more confident decisions during drug development, 3) genomics is changing the profile of successful products by suggesting the possibility of more effective medicines with fewer side effects, and 4) to the extent that policies encouraging innovation and access to new drugs are in conflict with health cost containment efforts, decision-makers need to find a solution that provides for both priorities.

POPI WP #58-01
The Contributions of Science and Technology in Advancing Society’s Needs through Drug Development
Sarah C. Stallings, Robert H. Rubin, Thomas J. Allen, et al.
February 2001
The burden of disease and the provision of health care are fundamental concerns worldwide. The pharmaceuticals that result from innovation are uncommonly valuable tools for health care. The scientific and technological advances behind today’s medicines develop over sometimes long periods of time in a compounding manner. History has demonstrated that if basic scientific research is supported and innovation is encouraged, technology generates more technology, and during the lag between technological advances and clinical successes, benefits to biomedical science accrue continually.

Advances in science and technology are providing opportunities to develop drugs that address three major problems with pharmaceutical use in clinical medicine: Diseases for which there are no, or only insufficient, therapies; Serious or even fatal side effects of drugs, and Efficacy that varies unpredictably between individuals. Now biomedical capabilities are providing information and tools for the creation of useful models of complex biological systems. The increasing knowledge and relevant models will lead to new therapies for unmet medical needs and safer and more effective medicines in two ways: first by expanding the understanding of disease, and second by decreasing the uncertainty around component decisions in drug development. Effective application of advances in science and technology to discovering and developing new drugs will be necessary to capture these opportunities for the benefit of public health.

POPI WP #57-00
Lost Work Productivity and Absenteeism Among Parents of Children with Asthma
Stan N. Finkelstein, Iain M. Cockburn, Howard L. Bailit, et al.
November 2000
CONTEXT : Asthma poses an enormous burden, in terms of prevalence and economic terms. Its annual cost burden, estimated to exceed $6 billion dollars in the U.S., is likely to be understated due to the difficulty in measuring, objectively certain indirect costs.
OBJECTIVES : To examine the cost impact among parents of children with asthma who suffer lost productivity or absenteeism from work due to exacerbations or lapses in the control of the children’s asthma symptoms.
DESIGN AND SETTING : Multivariate statistical methods were used to analyze a de-identified retrospective dataset covering nearly 6000 workers in the same data entry occupation, employed at the same firm, over the period of January 1993 – June 1995. Daily objective measures of work productivity have been linked to patterns of asthma care among the workers and their dependent children.
MAIN OUTCOME MEASURES : Daily work productivity, measured as complexity-adjusted data entry throughput and absenteeism measured before, during and after episodes of exacerbation of asthma.
RESULTS : On average, workers experienced a 12% reduction in daily work productivity at the beginning of an episode of their children’s asthma care.
CONCLUSION : The indirect economic burden on employed parents of children is potentially enormous. Successful efforts to improve compliance with asthma treatment regimens leading to fewer exacerbation would be likely to greatly reduce that burden.

POPI WP #56-00
The U.S. Pharmaceutical Industry: Why Significant Growth in Times of Cost Containment?
Ernst R. Berndt
September 2000
Particularly since 1994, growth in utilization rather than growth in prices has been the primary driver of increased prescription pharmaceutical expenditures in the US. But what are the drivers of utilization growth?In this paper, I focus on four factors that have increased utilization, even as cost containment efforts have flourished: (i) “the importance of being unimportant”; (ii) increased third party prescription drug insurance coverage; (iii) the introduction of successful new products; and (iv) aggressive technology transfer and marketing efforts by pharmaceutical firms. I also consider what roles these four factors are likely to play in the future.

POPI WP #55-00
The Treatment of Depression, 1991-1996: Productive Inefficiency, Expected Outcome Variations, and Price Indexes
Ernst R. Berndt, Anupa Bir, Susan H. Busch, et al.
January 2000
A common perception is that increases in mental health spending over the last decade reflect increasing costs of treatment. But are increased mental health expenditures due to price increases, quantity (volume) increases, or some combination? This question raises important measurement issues.Recently researchers and health care policy analysts have renewed professional interest in constructing price indexes for episodes of treatment for an illness, rather than focusing measurements on changing medical care input prices. By pricing episodes of care, the overall cost impacts of changing treatment modalities can be taken into account, incorporating therapeutic substitution among inputs, technological progress, and effects of cost containment.

POPI WP #54-99
Network Effects and Diffusion in Pharmaceutical Markets: Antiulcer Drugs
Ernst R. Berndt, Robert S. Pindyck & Pierre Azoulay.
March 1999
We examine the role of network effects in the demand for pharmaceuticals at both the brand level and for a therapeutic class of drugs. These effects emerge when use of a drug by others conveys information about its efficacy and safety to patients and physicians. This can lead to herd behavior where a particular drug — not necessarily the most efficacious or safest — can come to dominate the market despite the availability of close substitutes, and can also affect the rate of market diffusion. Using data for H2-antagonist anti-ulcer drugs, we examine two aspects of these effects. First, we use hedonic price procedures to estimate how the aggregate usage of a drug affects brand valuation. Second, we estimate discrete-time diffusion models at both the industry and brand levels to measure the impact on rates of diffusion and market saturation.

POPI WP #53-99
Exploring the Diffusion of Science Driven Drug Discovery in Pharmaceutical Research
Iain Cockburn, Rebecca Henderson & Scott Stern
April 1999
There is considerable evidence that there are significant and persistent “fixed effects” across firms. Empirical work in industrial organization routinely controls for firm fixed effects. These are usually statistically significant, often accounting for a substantial fraction of the variation of the independent variable, and in many contexts controlling for fixed effects has quite dramatic effects on estimated coefficients. A number of interpretations of this phenomenon have been offered.One interpretation focuses on the role of fixed effects in controlling for a number of standard measurement problems. The productivity literature, for example, faces substantial difficulties in computing capital stocks from accounting data, dealing with firm-specific input and output prices, controlling for unobservable factors of production such as managerial effort and so on. Studies of R&D performance face the very serious problem that even within tightly defined industries firms may differ substantively in the range of technologies in which they invest, and hence in the technological opportunity sets that they face. To the extent that these kinds of unobserved heterogeneity persist within the firm over time, and are correlated with observed variables in the model, then failing to control for firm effects can have quite serious consequences. One view, therefore, is that firm dummies are essentially nuisance parameters which are important to estimate but are of little economic interest in and of themselves.

POPI WP #52-99
Health Care Utilization and Productivity at a Large National Data Processing Company: Are Anxious Employees Different?
Ernst R. Berndt, Howard L. Bailit, Martin B. Kelleret al.
June 1999, Revised July / August 2000
We examine the diagnosed prevalence of mental disorders among data processing employees at a large US employer. We compare average objective productivity performance of employees diagnosed with various mental disorders to random set of employees, we document their differential health care service utilization and expenditures, and we examine patterns of comorbidities among the mental disorders and with other somatic illnesses. We find that employees diagnosed with anxiety have extensive comorbidities with other mental disorders and with somatic diseases, and that the health care utilization and expenditures claims implications of these comorbidities are substantial.

POPI WP #51-99
Do Pharmaceutical Sales Respond to Scientific Evidence?
Pierre Azoulay
April 1999
This paper investigates how different sources of information influence the diffusion of pharmaceutical innovation. In prescription drug markets, both advertising and scientific information stemming from clinical trials can affect physicians’ prescription choices. Using a novel index of clinical research output, I find that both marketing and scientific evidence directly influence the diffusion process in the anti-ulcer drug market, with marketing having a more pronounced impact. I also find strong evidence that clinical outputs are important drivers of firms’ marketing efforts, affecting sales indirectly. Taken together, the direct and indirect effect of science on demand imply strong private incentives for clinical research. I conclude that product market competition in the pharmaceutical industry is shaped both by advertising rivalries and scientific rivalries. Moreover, drug advertising performs an important informative function.

POPI WP #50-99
Balancing Incentives: The Tension Between Basic and Applied Research
Iain Cockburn, Rebecca Henderson & Scott Stern
December 1998
This paper presents empirical evidence that the intensity of research workers’ incentives for the distinct tasks of basic and applied research are positively associated with each other. We relate this finding to the prediction of the theoretical literature that when effort is multi-dimensional, firms will “balance” the provision of incentives; when incentives are strong along one dimension, firms will set high-powered incentives for effort along other dimensions which compete for the worker’s effort and attention. We test for this effect in the context of pharmaceutical research using detailed data on individual research programs financed by private firms. Consistent with the complementarity hypothesis, we find strong evidence that firms who provide strong promotion-based incentives individuals to invest in fundamental or “basic” research also provide more intense incentives for success in applied research through the capital budgeting process. The intensity of these “bonus” incentives is weaker in firms who use a more centralized research budgeting process. We interpret this latter finding as providing support for theories which emphasize substitutability between contractible and non-contractible signals of effort.

POPI WP #49-99
Patient Welfare and Patient Compliance: An Empirical Framework for Measuring the Benefits from Pharmaceutical Innovation
Paul Ellickson, Scott Stern & Manuel Trajtenberg
December 1998
The main goal of this paper is to develop an empirical framework for evaluating the patient welfare benefits arising the pharmaceutical innovation. Extending previous studies of the welfare benefits from innovation, this paper unpacks the separate choices made by physicians and patients in pharmaceutical decision-making and develops an estimable econometric model which reflects these choices. Our proposed estimator for patient welfare depends on (a) whether patients comply with the prescriptions they receive from physicians and (b) the motives of physicians in their prescription behavior. By focusing on compliance behavior, the proposed welfare measure reflects a specific economic choice made by patients. We review evidence that the rate of noncompliance ranges up to 70%, suggesting an important gulf between physician prescription behavior and realized patient welfare. Since physicians act as imperfect but interested agents for their patients, the welfare analysis based on compliance must account for the nonrandom selection of patients into drugs by their physicians. The key contribution of this paper resides in integrating the choices made by both physicians and patients into a unified theoretical framework and suggesting how the parameters of such a model can be estimated from data.

POPI WP #48-99
Project Management and the Performance of Drug Development Teams
Thomas J. Allen, Ralph Katz, Frank Basa, et al.
This questionnaire survey study of 57 drug development teams examines how the locus of decision influence between project leaders and departmental managers affects the performance of drug development projects at the US R&D laboratories of eight large, multinational pharmaceutical firms. Project performance is higher when team members perceive functional managers to have greater influence over go/no go decisions during early and late phases. Project performance is also higher when project leaders have greater influence over clinical decisions during later phases. The technical knowledge of the project leader is related to project performance in a complex fashion. Technically knowledgeable project leaders are more effective during late phase projects. During early phases, project leaders who are rated as having greater technical knowledge head lower performance teams.Across firms in the sample, team members do not feel that teams have autonomy to carry out their mission, organizations do not have clear criteria for assessing team performance, and individual team member rewards are not linked to their performance as a project team member. These characteristics of the organizational milieu are also correlated with leadership structure. Dual leader firms appear to provide a better environment for project teams.The study examines a series of relationships among locus of decision making influence, project leader characteristics, organizational support for teams, project phase, leadership structure, and project performance. It concludes with guidelines for structuring organizations.

POPI WP #47-99
R&D Accounting and the Tradeoff Between Relevance and Objectivity
Paul M. Healy & Christopher D. Howe
January 1999
This paper develops a simulation model for a pharmaceutical firm to provide evidence on the tradeoff between objectively and relevance for several methods of reporting R&D outlays. The findings indicate that a simple capitalization rule, analogous to the successful efforts method of capitalizing oil and gas exploration costs, provides a significantly higher relation between accounting information and economic values than immediate expensing of R&D outlays or capitalizing the full cost of outlays. More importantly, our findings show the relevance of successful efforts data persists even when there is widespread earnings management.

POPI WP #46-98
Loss of Work Productivity Due to Illness and Medical Treatment
Iain M. Cockburn, Ernst R. Berndt, Howard L. Bailit & Stan N. Finkelstein
November 1998
OBJECTIVE: We examined the effects on work productivity of treatment with antihistamines in the retrospective study using linked health claims data and daily work output records for a sample of clerical workers
METHOD: Among nearly 6000 individuals employed as claims processors at a large US insurance company, 682 individuals filled at least one prescription for an oral antihistamine during the period January 1993 to July 1995. We estimate a multiple regression model to explain variation in work output. We consider separately the productivity impacts of “sedating” and “nonsedating” antihistamines, in addition to characteristics of the employees, their jobs, and day-of-week and month factors.
RESULTS: No significant impact on productivity is visible in the period immediately preceding the day on which patients obtained the drug. During the period after obtaining the drug, differences up to 13% in productivity are found between patients taking sedating and nonsedating antihistamines.
INTERPRETATION: The size of the observed effect suggests a substantial indirect economic cost from use of certain medical treatments. These kinds of costs have until now been largely overlooked, because work productivity has been difficult to measure objectively.

POPI WP #45-98
Empirical Implications of Physician Authority In Pharmaceutical Decisionmaking
Scott Stern & Manuel Trajtenberg
October 1998
This paper studies the consequences of physician authority on pharmaceutical prescribing. Physicians engage in a costly process of “matching” patients to the drug which most suits their particular conditions and characteristics. The relative efficiency of this matching process results from the diagnostic skill of the physician along with the investments made by the doctor in learning about different drugs. While the underlying level of physician skill or knowledge cannot be observed, differences among physicians in terms of these attributes are reflected in their prescribing behavior. We provide evidence for two major findings regarding the exercise of physician authority in this context. First, there is substantial variation in the degree to which physician prescribing is concentrated (i.e., some physicians prescribe a more diverse portfolio of drugs than others). Second, this concentration is correlated with observable drug characteristics. In particular, concentrated prescribers tend to prescribe drugs with high levels of advertising, low prices, and high (lagged) market shares. Our empirical results provide evidence for the importance of both physician effort and diagnostic ability in the prescribing process. In particular, physicians who differentiate among their patients more finely are more likely to have less concentrated prescribing portfolios and to be less sensitive to information sources which promote the use of drugs for the “average” patient.

POPI WP #44-98
Price Indexes for Medical Care Goods and Services: An Overview of Measurement Issues
Ernst R. Berndt, David M. Cutler, Richard G. Frank, et al.
September 1998
We review in considerable detail the conceptual and measurement issues that underly construction of medical care price indexes in the U.S., particularly the medical care consumer price indexes (MCPIs) and medical-related producer price indexes (MPPIs). We outline salient features of the medical care marketplace, including the impacts of insurance, moral hazard, principal-agent relationships, technological progress and organizational changes. Since observed data are unlikely to correspond with efficient outcomes, we discuss implications of the failure of transactions data in this market to reveal reliable marginal valuations, and the consequent need to augment traditional transactions data with information based on cost-effectiveness and outcomes studies.We describe procedures currently used by the BLS in constructing MCPIs and MPPIs, including recent revisions, and then consider alternative notions of medical care output pricing that involve the price or cost of an episode of treatment, rather than prices of fixed bundles of inputs. We outline features of a proposed new experimental price index — a medical care expenditure price index — that is more suitable for evaluation and analyses of medical care cost changes, than are the current MCPIs and MPPIs. We conclude by suggesting future research and measurement issues that are most likely to be fruitful.

POPI WP #43-98
Lost Human Capital From Early Onset Chronic Depression
Ernst R. Berndt, Lorrin M. Koran, Stan N. Finkelstein, et al.
Revised 2000
Most young adults pursue post high-school education in the ten to fifteen years immediately following high school graduation. By foregoing current income and incurring the tuition, board and textbook costs of higher education, individuals (and their financial sponsors) invest in the future. These higher education costs can be envisaged as one form of human capital formation and accumulation. Investment payoffs to the human capital accumulation of young adults include increases in expected productivity an earnings later in life.
The ability of young adults to successfully accumulate human capital depends in part on health status during the critical years in which most post-high school education and training typically occur, i.e., ages 18-30. Early age of onset illnesses and disorders associated with significant reduced physical, social and cognitive functioning are particularly burdensome. The costs of such disorders include not only direct and indirect medical costs, but also the reduced functioning and resulting impaired ability of the young to accumulate human capital, i.e., the costs of “lost” human capital. Detection and effective treatment of early onset disorders involving significant potential lost human capital could have very substantial economic benefits.

POPI WP #42-97
Illness and Productivity: Objective Workplace Evidence
Ernst R. Berndt, Stan N. Finkelstein, Paul E. Greenberg, et al.
May 1997
Health status can affect work performance in numerous ways. Economic analysis often focuses on long-term workplace outcomes that result from ill health, including changes in earnings, employment status, job choice, and promotion patterns. The medical and pharmacoeconomics literature also contain numerous examples of much more immediate consequences of illness in the workplace, in terms of excess absenteeism from work as well as impairment while at work.Although illnesses can lead to numerous types of adverse effects with respect to labor market outcomes, many of the longer-term consequences are not borne directly by any particular business firm or organization but rather by society as a whole. As a result, there may be little incentive in many instances for a particular company to intervene on behalf of individuals in addressing these specific workplace concerns. In contrast, a substantial portion of the more immediate adverse implications of illness are routinely felt by employers.

POPI WP #40-97
The Opportunity Cost of Chronic Illness in the Workplace – Mapping the Landscape
Stan N. Finkelstein, Ernst R. Berndt, Mark Moore, et al.
March 1997
Among the greater management challenges that employers have faced in the last decade have been achieving greater employee productivity and getting a handle on spiraling health care costs. Ideally, both challenges can be addressed with one set of policies that target employee health investments; such targeted policies enhance productivity by reducing the absenteeism and impairment while at work associated with ill health. Few would question the notion that a healthier workforce is more productive. Losses due to absenteeism, for example, have received considerable attention. Much of that attention has focused on injuries at work or illnesses closely tied to conditions at work. Here we adopt a more inclusive approach in order to capture the costs of absenteeism due to any illness that is prevalent in working-age populations, regardless of whether the “cause” of the illness is associated with work conditions. However, another aspect of the value of treating illness, better at-work employee performance, has received very little attention. Greater interest on the part of employers and policy-makers could very well follow if a credible set of metrics were available to document that improved at-work productivity resulted from better health. This paper offers the elements of a framework to help identify illnesses that can be targets of opportunity — targets for incremental additional investments in workplace health that could bring tangible economic returns to employers.

POPI WP #39-97
Marketing, Product Differentiation, and Competition in the Pharmaceutical Industry
Charles King III
November 1996
Marketing plays a major role in the promotion of pharmaceuticals, where marketing expenditures can range as high as 10 – 20% of sales. This paper investigates the role of marketing in product differentiation and competition in the ulcer drug market, one of the largest pharmaceutical markets. A variant of the discrete choice model of consumer behavior is developed that incorporates the effects of marketing by the firm and its competitors and that allows marketing to affect the scale of product differentiation. Using a panel of monthly data on four ulcer drugs from 1977 to 1993, the price and marketing elasticities of demand are estimated. These results suggest three primary effects of marketing during this period. First, marketing reduced firms’ own price elasticities of demand. Second, total marketing by all firms reduced the degree of product differentiation in the market and raised the cost of entry to potential competitors. Third, marketing initially expanded the market for ulcer drugs but later became an increasingly important means of stealing business from competitors.

POPI WP #38-96
Pharmaceutical Innovations and Market Dynamics: Tracking Effects on Price Indexes for Anti-Depressant Drugs
Ernst R. Berndt, Iain M. Cockburn & Zvi Griliches
The construction and publication of measures of price inflation are important tasks carried out by governmental statistical agencies. In the U.S., the Bureau of Labor Statistics publishes price indexes measured at the point of final consumer demand (the consumer price index, CPI), and at the initial production point, i.e., prices received by producers from whomever makes the first purchase (the producer price index, PPI). These price measurement tasks are difficult ones, particularly since new goods embody scientific discoveries and technological progress, inherent difficulties exist in measuring the output of services that themselves combine goods and time, and dynamic structural and compositional changes occur in the underlying markets for production, distribution and sale. The health care marketplace contains all these features and presents particularly difficult challenges for price measurement. Health care expenditures represent a significant portion of GDP, and are likely to become increasingly important as the US population ages. The conceptual foundations for a health care-related CPI are clouded by the fact that in the US, many but not all health care products and services are paid for by insurance plans; thus, for example, currently the CPI for prescription pharmaceutical products weights only cash payment transactions from drug stores and mail order outlets, and excludes HMO, Medicaid or other purchases on behalf of an individual.

POPI WP #37-96
Benchmarking Pharmaceutical Manufacturing Performance
Charles L. Cooney
Paper is not available at this time.

POPI WP #36-96
Market Definition and the Returns to Innovation: Substitution Patterns in Pharmaceutical Markets
Scott Stern
December 1996
This paper estimates a model of product demand within a number of pharmaceutical markets, where each market is composed of a number of substitute therapies (FDA-approved molecules). Each molecule may be sole by the pioneer (the patent holder) and generic competitors. A number of empirical anomalies within these markets motivate this research. In particular, despite very aggressive entry by generic vendors, the prices of pioneer products rose during the 1980s. A model of consumer choice, relying on the institutional details of pharmaceutical decision-making, is developed to derive the regression framework. This framework includes two important features. First, I explicitly parameterize the substitutability among molecules and between pioneer and generic products. Second, the endogeneity of firm-level choice variables (price and advertising) is accounted for by the use of instrumental variables. There are three principal findings. First, alternative pioneer products are relatively strong substitutes; in contrast, pioneer products often are substantially differentiated from their generic competitors. Second, pioneer firms wield market power, in part because they are multiproduct firms. Not accounting for the economics of multiproduct pricing reduces the degree of measured market power by up to 27%. An important corollary to these first two findings is that competition among pioneer firms provides an important check on pioneer market power. Finally, there is substantial variation among therapeutic markets. In the single market that did not experience new pioneer entry, there is little differentiation between the pioneer and generic sectors and relatively low intermolecular substitutability.

POPI WP #35-96
Incentives and Knowledge in Organizational and Technological Change: The Case of Drug Discovery in the 1980s
Scott Stern
December 1996
Since the 1930’s, extraordinary (though uneven) advances have been achieved in the chemical, biological and clinical sciences underlying drug discovery. Over this period, pharmaceutical firms have assimilated and exploited this underlying science base in different ways at different times; as well, some firms have been more aggressive than others in attempting novel organizational and/or scientific approaches to drug discovery. For example, starting in the late 1970s, some firms, such as Merck, started to provide strong support and high-powered incentives for collaboration and interaction with university-based scientists, while other firms, such as Bristol-Myers, maintained a more traditional (and less interactive) approach towards university research. Persistent differences in the management of drug discovery are somewhat puzzling, particularly since some strategies (such as openness to university science) have been found to be more “productive” than others. The goal of this paper is to understand the process by which particular practices and tools are adopted more closely. This paper examines the role that experience plays in shaping the underlying incentives and knowledge base that firms possess when contemplating adaptation to environmental change. In so doing, the difficulty inherent in the process of adaptation are highlighted through an examination of the challenges faced by firms in the 1980s as they attempted to respond to radical change in the biological sciences and computing technologies which underly drug discovery.

POPI WP #34-96
Do Agency Costs Explain Variation in Innovative Performance?
Iain Cockburn & Rebecca Henderson
There is considerable evidence that there are significant and persistent “fixed effects” across firms. The classic production function literature demonstrated that some firms were persistently “inside” the efficiency frontier, and more recent work exploring the determinants of research productivity using panel data has consistently suggested that there are large and persistent differences in firm performance that cannot be ascribed to traditional measures of labor, knowledge or physical capital. Some authors have even suggested that the percentage of variance in profitability across firms that can be attributed to firm effects may be significantly greater than the percentage that can be attributed to industry effects. These results are consistent with a long stream of work in the traditions of organizational behavior and strategic management which has suggested that organizations change only very slowly, despite the fact that differences across firms have important implications for both profitability and survival. They are also consistent with a vibrant managerial literature that exhorts senior management to adopt the latest techniques in organizational management, and they have given rise to a lively theoretical literature.

POPI WP #33-96
The Routinization of Radical Innovation: Pharmaceutical Firms and the Biomedical Revolution
Iain Cockburn & Rebecca Henderson
Paper is not available at this time.

POPI WP #32-96
Scale and Scope in Drug Development: Unpacking the Advantages of Size in Pharmaceutical Research
Iain Cockburn & Rebecca Henderson
July 1996
Pharmaceutical companies display large and persistent differences in their innovative capabilities. Using detailed data gathered at the project level from inside the R&D labs of ten major pharmaceutical companies, we examine the roots of differential performance in the development of new drugs. One of the most interesting features of these data is the ability to distinguish between “discovery” and “development” efforts: the processes of identifying potentially valuable new compounds in the lab, and of subsequent testing and fine-tuning these drug candidates in human trials. In previous work, we found substantial advantages to size in drug discovery, stemming as much from economies of scope and the ability to absorb R&D spillovers as from economies of scale per se in performing pharmaceutical research. Here we contrast these results with the factors which determine success in the drug development phase, where the technology of R&D is very different and where larger amounts of money are spent. While we find no evidence of straightforward economies of scale, we again find some evidence that larger firms benefit from the ability to take advantage of economies of scope. In contrast to our previous findings in drug discovery, however, this result is not robust to the inclusion of controls for firm effects. These results have interesting implications for the theory of the firm, as well as for policy-orientated interest in the links between market structure, firm size, and performance in this important industry.

POPI WP #31-96
Public-Private Interaction in Pharmaceutical Research
Iain Cockburn & Rebecca Henderson
We empirically examine interaction between the public and private sectors in pharmaceutical research using qualitative data on the drug discovery process and quantitative data on the incidence of co authorship between private institutions. We find evidence of significant reciprocal interaction, and reject a simple “linear” dichotomous model in which the public sector performs basic research and the private sector exploits it. Linkages to the public sector differ across firms, reflecting variation in internal incentives and policy choices, and the nature of these linkages correlates with their research performance.

POPI WP #30-96
Project Management and the Locus of Decision-Making in Drug Development
Frank Basa & Thomas J. Allen
This questionnaire survey study of 45 drug development teams examines how the locus of decision influence between project leaders and departmental managers affects the performance of drug development projects at the US R&D laboratories of six large, multinational pharmaceutical firms. The study examines a series of relationships among locus of decision making influence, project leader characteristics, organizational support for teams, project phase, leadership structure, and project performance.In this sample project performance is higher when team members perceive departmental managers to have greater influence over go/no-go decisions during both early and late phases of the development process. Project performance is also higher when project leaders have greater influence over clinical decisions during later phases. The technical knowledge of the project leader is related to project performance in a complex fashion. Technically knowledgeable project leaders are more effective during late phase projects. During early phases, project leaders who are rated as having greater technical knowledge head lower performing teams.

POPI WP #29-96
Workplace Performance Effects From Chronic Depression and Its Treatment
Ernst R. Berndt, Stan N. Finkelstein, Paul E. Greenberg, et al.
October 1997
Utilizing data from a clinical trial and an econometric model incorporating the impact of a medical intervention and regression to the mean, we present evidence supporting the hypotheses that for chronically depressed individuals: (i) the level of perceived at-work performance is negatively related to the severity of depressive status; and (ii) a reduction in depressive severity improves the patient’s perceived work performance. Improvement in work performance is rapid, with about two-thirds of the change occurring already by week 4. Those patients having the greatest work improvement are those with both relatively low baseline work performance and the least severity of baseline depression.

POPI WP #28-96
Improvement in Subjective Work Performance After Treatment of Chronic Depression: Some Preliminary Results
Stan N. Finkelstein, Ernst R. Berndt, Paul E. Greenberg, et al.
We analyzed the relationship between depression and patient-assessed or clinician-rated work performance among chronically depressed patients followed for 12 weeks in a large clinical trial.The data were collected in a double-blind design comparing sertraline, a selective serotonin reuptake inhibitor, with imipramine, a tricyclic antidepressant, in 12 academic centers nationwide. Incorporating work-related questions from a portfolio of rating scales used to assess depression, we constructed several measures of work performance, assessed at baseline and at Week 12 of the clinical investigation, and examined how they changed with improvement in depressive symptoms. As depressive symptoms subsided following treatment, patients reported substantial improvement in our measures of work performance. Eighty-six percent of the cohort reported some improvement from base-line to Week 12. The extent of improvement in work performance correlates highly with improvement in the depressive symptoms measured on the Hamilton Rating Scale for Depression. Treatment of depression with antidepressant medications resulted in substantial improvement in subjective work performance among the patients studied.

POPI WP #27-96
Organizational Ecology in the 90s: A Review and an Assessment
Bart Clarysse, Koen Debackere & Peter Temin
February 1996
Organizational ecology is evolving from a collection of rather unrelated concepts towards an integrated model of business failure and founding. Despite this increasing convergence within the ecological boundaries, little integration occurs with other intellectual streams. This paper presents a review of the theoretical models developed during the past five years and an assessment of future research opportunities: can institutional theory, strategic management and industrial economics enrich and stretch the boundaries of the ecological model?

POPI WP #26-96
Economies of Scale in the Pharmaceutical Industry
Peter Temin, Stan Finkelstein & Bart Clarysse
February 1996
Conventional wisdom about the United States pharmaceutical industry is based on the observation that there is market power in the sales of individual drugs. This market power is thought to derive from patent monopolies on new drugs and from economies of scale in pharmaceutical R&D, in shepherding new drugs through the regulatory process and in marketing. Economic analyses of the industry have been concerned largely with measuring and alleviating this power.But the pharmaceutical industry cannot be seen simply as a collection of monopoly markets. There also are economies of scope within the pharmaceutical industry, and virtually all firms in the industry sell a multiplicity of drugs. Many if not most markets for individual drugs have at least some competition, either because the patent has expired or because there exist closely substitutable drugs. And since patents are only temporary, new drugs have to be introduced continually to maintain market power.

POPI WP #25-94
A Primer on Issues in the Measurement of Price Change and Price Impact: An Application to Pharmaceuticals
Alison Keith & Ernst R. Berndt
September 1994
The interest in finding reliable measures of how prices change over time is by no means new. When writing Chronicon Preciosum in 1707, William Fleetwood, the Bishop of Ely, computed a price index for the living costs of an Oxford student 1707 compared to those of an Oxford student of 1460. He added up the costs of five quarters of wheat, four hogsheads of beer, and six yards of cloth and took the 1707 / 1460 total cost ratio as a price index. Several decades later, the Legislature of the Commonwealth of Massachusetts generated its own market basket to index the pay of soldiers fighting in the Revolutionary War. (The need to find a reliable standard for adjusting pay was created by the rapid inflation that had drastically reduced the real value of the fixed nominal pay of the soldiers). According to Willard Fisher, the 1780 legislation decreed that the basket was to consist of five bushels of corn, 68 and 4/7 pounds of beef, ten pounds of sheep’s wool and sixteen pounds of sole leather.Today measures of price change are widely used, by businesses for assessing performance and for business planning, by diverse participants engaged in public policy debates, and by workers involved in labor-management disputes. Certain price measures are required to be disclosed publicly by companies. Specific measures are even incorporated into laws, regulations and contracts. In the U.S., these measures are typically drawn from the standard price index series produced by the government’s Bureau of Labor Statistics (BLS), such as the Consumer Price Index (CPI) and the Producer Price Index (PPI).

POPI – WP #24-94
Gene Therapy: Biotech’s n+1 Technology
Nevin M. Summers & Charles C. Cooney
February 1993
The history of technological advancement shows that innovation is initially often dismissed as impractical — and ignored. By the time the incumbent technology recognizes the new technology’s threat it is too late. The new technology supplants the existing way of doing things and gradually establishes market dominance. The history of biotechnology is an apt example of this process. As many industry observers have pointed out, if pharmaceutical companies had initially recognized the power of recombinant DNA drugs, there might be no biotechnology industry today. Pharmaceutical companies would have developed the technology internally, maintaining absolute dominion over the health-care industry. Understanding when an emerging technology is on the verge of launching a threat to your business allows you to steer your company in a direction that will take advantage of that change.

POPI WP #23-94
Variable Rate Sequential Testing: Another Approach to Clinical Trials?
Michael Miller & Arnold Barnett
Paper is not available at this time.

POPI WP #22-94
The Strategic Response by Pharmaceutical Firms to the MFN Clause in the Medicaid Rebate Law of 1990
Fiona Scott Morton
January 1994
A Most Favored Nation contract between the buyer and seller of a good requires the seller to give the buyer the lowest price offered to any other buyer. Many theoretical models have shown that a Most Favored Nation clause commits a firm to compete less aggressively in prices. The Federal Government imposed such a rule in 1990 to govern the prices it would pay firms for pharmaceutical products supplied to Medicaid recipients. The firms had to give Medicaid their “best,” or lowest, price. I show that average market prices rose after the MFN clause was implemented. Generic firms were not subject to the MFN rule and generic prices did not rise after the regime change. However, markets with three or fewer generic firms and one brand firm show a small rise in the generic price. The strategic externally is more concentrated in this situation. The MFN law was not a good policy choice; the higher prices it caused reduced consumption of pharmaceuticals and lowered national welfare.

POPI WP #21-94
Barriers to the Entry, Brand Advertising, and Generic Entry in the U.S. Pharmaceutical Industry
Fiona Scott Morton
January 1994
This paper models the entry decisions of generic pharmaceutical manufacturers into markets opened by patent expiration. In particular, Scott Morton examines the role of pre-expiration brand advertising to see if it deters generic entry. Other market characteristics affect the number of entrants; the most important of these is pre-expiration brand revenue. Drugs with high hospital share and those that treat chronic conditions also attract more entry. The previous literature has assumed advertising is exogenous to the entry decision when analyzing the role of advertising. The results under this hypothesis indicate that brands can deter generic entry very slightly by advertising before patent expiration. When instrumented, the coefficient on advertising more than doubles; however, its deterrent effect is still relatively small. I conclude that brand advertising is a barrier to entry by generic firms, but the effect is not strong enough to be of concern to entrants or policy makers.

POPI WP #20-94
Challenge and Response in the Pharmaceutical Industry
Rebecca Henderson
The continued vitality of the most successful U.S. and European pharmaceutical companies, in the face of accelerating scientific and technological change, holds valuable lessons for managers in all industries trying to respond to turbulent times. The pharmaceutical industry faces some serious challenges in the future, most notably the proposed reform of the U.S. health care system. Yet is success to date in the crucial area of research can serve as a benchmark for companies seeking to become more innovative in the overloaded environment of the information age. New competitors skillfully exploiting a wave of technological change have displaced or seriously challenged the companies that once dominated such industries as machine tools, steel, xerography, automobiles, semiconductors, and computers. In contrast, companies founded in the 1940s and 1950s continue to dominate the pharmaceutical industry. These companies have demonstrated an ability to learn and grow that confounds conventional wisdom. Despite their age, size, and success, the best of these companies have found ways to retain the flexibility and responsiveness of companies one-tenth their size and age. And they have already solved some of the competitive challenges in the research arena that companies in other industries are just starting to grapple with.

POPI WP #19-94
The Roles of Marketing Product Quality and Price Competition in the Growth and Composition of the U.S. Anti-Ulcer Drug Industry
Ernst R. Berndt, Linda T. Bui, David H. Reiley, et al.
The introduction of Tagamet in the United States in 1997 represented both a revolution in ulcer therapy and the beginning of an important new industry. Today there are four prescription H2-antagonist drugs: Tagamet, Zantac, Pepcid, and Axid, and they comprise a multi-billion dollar market for the treatment of ulcers and other gastric acid conditions. In this paper, we examine the determinants of sales in this market, using a carefully constructed data set made possible by IMS America. We concentrate particularly on the marketing of these drugs to physicians through detailing and medical journal advertising, and we make an innovative attempt to distinguish between “industry-expanding” and “rivalrous” marketing efforts. We find that the impact of total marketing on the expansion of overall industry sales declines as the number of products on the market increases. In addition, we find that the stock of industry-expanding marketing depreciates at near-zero rate, while the stock of marketing oriented towards rivalrous market share competition depreciates at a 40% annual rate. We also find that the products’ sales are affected significantly by price, quality attributes (such as dosage frequency and FDA-approved indications), and order of entry into the market.

POPI WP #18-94
Racing or Spilling? The Determinants of Research Productivity in Ethical Drug Discovery
Iain Cockburn & Rebecca Henderson
In 1971, the member of the Pharmaceutical Manufacturer’s association spent about three hundred and sixty million dollars on research and development. In 1991, they spent 8.9 billion, an increase of over two thousand three hundred percent. But while industry sales have grown in line with research expenditures, there has been no significant increase in the number of new drugs introduced. Why have costs increased so dramatically? Breakthroughs in pharmaceutical research can lay the groundwork for qualitative improvements in the quality of life and for significant reductions in the cost of health care, but escalating health care costs have focused attention on every aspect of health care expenditure and have led several observers to question this apparent decline in pharmaceutical research productivity. This paper hopes to contribute to this debate by exploring the issue in the context of a broader study of the determinants of research productivity in ethical drug discovery.

POPI WP #17-94
Investment Behavior and Financial Structure: The Case of the Japanese Pharmaceutical Industry
Kaivan D. Munshi & Michael R. Reich
December 1993
Strengthening the firm-bank relationship to reduce information problems associated with the debt contract leads to a new incentive problem. The bank receives the same return in all success-states under a standard debt contract, resulting in a concave payoff function. A close firm-bank relationship may thus allow the bank to promote the choice of excessively safe investment projects. The costs of this distortion could, in principle, dominate the benefits of the increased access to capital associated with a close firm-bank relationship. We demonstrate the importance of the incentive problem for the case of the Japanese pharmaceutical industry. The choice of R&D investments in that industry is found to have been severely constrained prior to the financial deregulation of the 1980s. Since the incentive problem has the potential to be particularly serious in R&D-intensive industries, we conjecture that this result may have more general implications for the global competitiveness of Japanese high-tech industries in the future.

POPI WP #16-94
The Economic Burden of Depression in 1990
Paul E. Greenberg, Laura E. Stiglin, Stan N. Finkelstein, et al.
We estimate in dollar terms the economic burden of depression in the United States on an annual basis. Using a human capital approach, we develop prevalence-based estimates of three major cost-of-illness categories: (1) direct costs of medical, psychiatric, and pharmacologic care; (2) mortality costs arising from depression-related suicides; and (3) morbidity costs associated with depression in the workplace. With respect to the latter category, we extend traditional cost-of-illness research to include not only the costs arising from excess absenteeism of depressed workers, but also the reductions in their productive capacity while at work during episodes of the illness. We estimate that the annual costs of depression in the United States total approximately $43.7 billion. Of this total, $12.4 billion — 28% — is attributable to direct costs, $7.5 billion — $17% — comprises mortality costs, and $23.8 billion — 55% — is derived from the two morbidity cost categories. Depression imposes significant annual costs on society. Because there are many important categories of cost that have yet to be estimated, the true burden of this illness may be even greater than is implied by our estimate. Future research on the total costs of depression may include attention to the comorbidity costs of this illness with a variety of other diseases, reductions in the quality of life experienced by sufferers, and added out-of-pocket costs resulting from the effects of this illness, including those related to household services. Finally, it may be useful to estimate the additional costs associated with expanding the definition of depression to include individuals who suffer from only some of the symptoms of this illness.

POPI WP #15-94
Depression: A Neglected Major Illness
Paul E. Greenberg, Laura E. Stiglin, Stan N. Finkelstein, et al.
Recognition of depression as a major illness has been slow in developing. Given the widespread prevalence and the enormous burden depression imposes on society, this article asks why the illness has not received more attention from the medical and public health communities — especially primary care physicians — employer groups, as well as society at large. We argue that the characteristics of the illness itself and the manner in which it exacts a toll on sufferers tend to reduce public awareness of the magnitude of this problem. We present estimates of the number of people who suffer from depression in the United States and the annual cost associated with this illness. These estimates underscore the appropriateness of classifying depression as a major public health concern. We then present a framework for contrasting depression with other diseases using several criteria: economic costs, prevalence, distribution of sufferers, mortality, recognition, and treatability.

POPI WP #14-94
Public Policy and Pharmaceutical Innovation: A Literature Review and Critique
Alan N. Afuah
This paper reviews nine studies of the effects of national public policy on innovation in the pharmaceutical industry. The studies suggest that the innovativeness of the local industry is promoted by increased local funding for basic research, tight patent protection, strict safety and efficacy laws and incentives for investment in R&D, but that local innovativeness is substantially reduced by the imposition of price controls. However, the paper suggests that more research is needed before differences in local public policy regimes can be unambiguously linked to differences in the innovativeness of the local pharmaceutical industry. Changes in public policy often interact with each other in unpredictable ways and have quite unexpected effects.

Racing to Invest? The Dynamics of Competition in Ethical Drug Discovery
Iain Cockburn & Rebecca Henderson
Recent advances in the theoretical literature have greatly expanded our understanding of the forces that shape the competitive dynamics of research and development, but a paucity of sufficiently detailed empirical data has left these insights relatively untested. We draw on unusually detailed qualitative and quantitative internal data provided at the research program level by 10 major pharmaceutical firms to explore the usefulness of the modern literature as a source of insight into the dynamics of competition in ethical drug discovery. Our analysis focuses on one particularly compelling aspect of the literature: the suggestion that in “winner take all situations”, competition in R&D becomes a Prisoner’s Dilemma, leading to overinvestment in research. Without adequate measures of the social return to innovation, we can say nothing about whether there is “too much” or “too little” research undertaken by the industry, but our results do not support the suggestion that R&D investment in drug discovery is driven by the “tit-for-tat” or simple reaction function models hinted at by the institutional literature. First, R&D investment is only weakly correlated across firms once common responses to exogenous shocks are accounted for, and second, rivals’ R&D results are positively correlated with own research productivity, which we interpret as evidence for extensive R&D spillovers rather than the depletion externality implied by “winner take all” models.

POPI WP #12-94
Measuring Core Competence? Exploring Firm Effects in Pharmaceutical Research
Rebecca Henderson & Iain Cockburn
Renewed interest in the resource-based theory of the firm has focused attention on the role of heterogeneous organizational ‘competence’ in competition. This paper attempts to measure the importance of these effects in the context of pharmaceutical research. We distinguish between ‘component’ and ‘architectural’ competence, and using internal firm data at the program level from 10 major pharmaceutical companies show that together the two forms of competence appear to explain a significant fraction of the variance in research productivity across firms. Our results raise some intriguing questions about the nature of competencies and the ways in which they diffuse over time. There has recently been a revival of interest in the ‘resource-based view of the firm’. Those working within this tradition have drawn inspiration from the work of authors such as Selznick (1957) and Penrose (1959), and have suggested that inimitable firm heterogeneity, or the possession of unique ‘competencies’ or ‘capabilities’, may be an important source of enduring strategic advantage. This perspective promises to be an important complement to the strategic management field’s more recent focus on industry structure as a determinant of competitive advantage.

POPI WP #11-94
“Benchmarking” Pharmaceutical Manufacturing Performance
G. K. Raju & Charles L. Cooney
The continuing and dramatic changes in the pharmaceutical industry structure in recent years have left many pharmaceutical companies searching for the appropriate response. In this work, we explore the role that manufacturing can play in responding to the demands placed on the industry by these changes.
Our approach in this work has been to use “benchmarking” as a means to characterize the current state of pharmaceutical manufacturing and contrast it with the desired future state. Lead benchmarking partnerships were formed with 14 different pharmaceutical plants representing the brand name, generic and biotechnology segments of the industry. Using qualitative interviewing, and function and sub-process based questionnaires, performance was measured in these plants to identify the opportunities for improvement.
Preliminary results from our benchmarking study indicate that: 1) There is a need to benchmark core sub-processes within the plant rather than functional areas; 2) Manufacturing is still viewed as a cost center. This view is associated with a defensive mindset towards manufacturing; 3) Inventory management represents a significant opportunity within the industry. Many plants have high inventory levels worth up to $50 million in tied up capital. This represents an inventory level in excess of $30 billion for the global industry; 4) There is a large opportunity associated with the supplier management process. This is indicated by high raw material inventory levels, high QC test and release times, the number of defective lots passed, the % of vendor lots not accepted and the number of suppliers; 4) Cycle time reduction is a very large opportunity are within pharmaceutical manufacturing. Preliminary evidence indicates that more than 90% of the cycle time in pharmaceutical manufacturing is spent in non value-added activities. Within the context of the cost of quality framework, it seems clear that the pharmaceutical industry is keenly focused on minimizing external failure costs through appraisal (inspection); and 5) There is a large opportunity to move the focus from external to internal failure costs and from appraisal to prevention. There are many promising future directions from this study. They include consistency analysis, additional metrics, both a lower level and higher level of analysis, increased collaboration with benchmarking partners, interaction between R&D and manufacturing, the impact of regulation and a study of best-practices in other industries.

POPI WP #10-94
The Economic Costs of Affective Illness in 1990
Ernst R. Berndt, Stan N. Finkelstein, Paul E. Greenberg, et al.
November 1993
Paper is not available at this time

POPI WP #9-94
Managing the Drug Development Process: A Preliminary Report on Project Management in the Pharmaceutical Industry
Frank Basa & Thomas J. Allen
While project management has existed, in one form or another, certainly since the days of pyramid construction in ancient Egypt, the modern day conception of project management emerged only very recently in the aerospace, computer and construction industries. Modern project management techniques developed as managers in these industries attempted and learned to better control large-scale projects. Project management has had a much shorter history in the pharmaceutical industry. In that industry, the earliest attempts date back only to the 1970’s. The slow adoption of project management in the pharmaceutical industry can be attributed to two factors: the strong disciplinary focus of the work force and the relative affluence of the industry. Pharmaceutical firms have traditionally had strong functional orientations due to the highly skilled and rather narrowly focused professional R&D workforces whose loyalties have often lain with their academic discipline. Concomitant with this was a munificent environment that allowed researchers to operate with little concern over the economic aspects of R&D. There was little pressure to control costs or to compress schedules. For many scientists and physicians in the industry, commercial considerations were secondary.

POPI WP #8-93
Price Controls and the Competitiveness of Pharmaceutical Firms: A Preliminary Look at the Experience of Five Countries
Stan N. Finkelstein & Peter G. Bittinger
To compete successfully in global markets, pharmaceutical firms must develop innovative and global drugs — those that represent therapeutic breakthroughs and that are targeted at categories not exclusive to the domestic market. A firm’s ability to do this successfully is determined at least partly by whether the domestic climate itself establishes these conditions for success. Why is the domestic climate important? The drug companies of every major country (except Switzerland) depend on their home market for a significant portion of their sales. Thus, a domestic climate that provides no incentives and resources for the research and development activities necessary to develop innovative and global drugs can have a major negative impact. The national policies that often establish the climate in which a domestic pharmaceutical operates — while not the sole determinants of international competitiveness — are important factors in the equation. These policies often define whether sufficient R&D incentives, and the resources to realize R&D plans, will exist. The effects of price and profit regulation can be large factors in international competitiveness.
There are strong interrelationships among investment in R&D, national policy, profitability, and reward for innovation. If regulation truly rewards innovation and provides the resources to take the risks that achieve innovation, the domestic market conditions will provide a solid foundation for a globally competitive pharmaceutical industry. In fact, the R&D focus of a country’s pharmaceutical industry is largely shaped by the national policies, and the level of investment in R&D general reflect whether a firm can achieve profitability in the domestic market through innovation, given national regulations.

POPI WP #7-92
The Business of Gene Therapy: Promises and Reality
Joseph J. Chow & Charles L. Cooney
Just a decade ago, gene therapy seemed like a radical idea that existed only in the realm of science fiction. Gene futurists envisioned a world in which genetic diseases would be virtually eliminated by technologies to replace defective human genes with functional ones. Alarmists feared a world in which irresponsible research would lead to genetically engineered superhumans with dreams of global domination. Today, the vision of the futurists is rapidly evolving into an attainable reality and the fears of the alarmists have been allayed by responsible science and successful clinical trials. Over the last decade, gene therapy research has progressed beyond studies in animal models to clinical trials in human beings. The first authorized human gene therapy experiment was conducted in 1990 in the United States. The experiment involved a child suffering from a rare inherited disorder caused by a faulty gene. The genetic defect impaired the little girl’s immune system, confining her to live her life in an isolation chamber. To carry out the gene therapy, a small amount of her cells was removed and “transduced” with special viruses. The viruses transferred normal, functional copies of the gene to her cells. The cells were then re-implanted. Almost two years later, the little girl is reported to be doing remarkably well and living a normal life. Since the, rapid progress continues to be made. By early 1992, a total of 17 gene therapy trials had been approved by the NIH’s Recombinant DNA Advisory Committee and seven more are under consideration. Within the next two years, the NIH expects a quadrupling of applications to conduct gene therapy experiments in humans. In the tradition of the biotechnology industry, new companies have been formed to commercialize advances in gene therapy technology. Supported by venture capital funding, these companies have set out transform newly developed gene transfer and cell transplantation technologies into profitable products and/or services. How gene therapy technologies are being transformed into commercial enterprises is the subject of this paper.

POPI WP #6-92
Price Indexes for Anti-Hypertensive Drugs that Incorporate Quality Change: A Progress Report on a Feasibility Study
Ernst R. Berndt & Stan N. Finkelstein
Paper is not available at this time.
The health care industry is one of the more rapidly growing industries in the U.S. today. In 1970, for example, health care costs were 7.3% of the GNP, but by 1992, they have risen to an estimated 13.4% of the GNP. Within the health care chain, the prescription pharmaceutical industry has become increasingly visible. While prescription drugs and related supplies account for only 7% of the total health care bill, consumers are particularly well aware of price trends in pharmaceutical products, for patient co-payment is about 70% — much larger than for most other components of health care. Another factor contributing to the visibility of the pharmaceutical industry is its recent record of prosperity and profitability. The July 29, 1991 issue of Fortune magazine called the pharmaceutical industry “America’s Most Profitable Business,” which the April 20, 1992 issue noted that in 1991 the pharmaceutical industry outperformed every other industry in terms of returns on sales (12.8% vs. 3.2% for the median Fortune 500 firm), returns on assets (12.1% vs. 3.7%) and returns on common equity (26.1% vs. 10.2%). And while in terms of sales the pharmaceutical industry was 11th in the U.S., in terms of accounting profitability, it was second.

POPI WP #5-92
The Evolution of Integrative Capability: Innovation in Cardiovascular Drug Discovery
Rebecca Henderson
Recent research has highlighted the ability to integrate fragmented knowledge across boundaries within a firm as a potentially potent source of competitive advantage. Yet this research raises a potentially puzzling question: if these capabilities are so central to competitive advantage, why do they not instantaneously diffuse across an industry? This paper draws on a detailed field study of the development of hypertensive drugs in 10 major European and American firms to explore this issue. I suggest that any particular integrative competence rests on a complex set of interlinked factors that usually evolve only slowly over time. Those firms that were fortunate enough to have focused early on more ‘rational’ modes of drug discovery have been much more successful in developing the integrative capabilities fundamental to modern drug discovery than those that initially achieved great success with the more traditional ‘random’ method of drug discovery. The results thus speak directly to evolutionary theories of competence development. They also raise intriguing questions about the relationship between the development of competence and the larger institutional context of the industry, since both the wealth and prominence of public sector biomedical research and the use of mechanism of action as an integrative device appear to have shaped the formation of capability in the industry.

POPI WP #4-92
Scale, Scope, and Spillovers: The Determinants of Research Productivity in Drug Discovery
Rebecca Henderson & Iain Cockburn
We examine the relationship between firm size and research productivity in the pharmaceutical industry. Using detailed internal firm data, we find that larger research efforts are more productive, not only because they enjoy economies of scale, but also because they realize economies of scope by sustaining diverse portfolios of research projects that capture internal and external knowledge spillovers. In pharmaceuticals, economies of scope in research are important in shaping the boundaries of the firm, and it may be worth tolerating the static efficiency loss attributable to the market power of large firms in exchange for their superior innovative performance. Are the research efforts of larger firms more productive than those of their smaller rivals, and if so, why? Answers to these questions speak directly to two central problems in the economics of industrial organization. In the first place, the relationship between the size of a firm and its innovative performance plays a central role in the analysis of industry structure, innovation, and the tradeoff between static and dynamic efficiency. In the second place, economies of scope and scale in research and development (R&D) play an important role in the theory of the firm: well-known problems in the market for information imply that they are fundamental to the existence of multi-product firms.

POPI WP #3-92
Technical Progress and Product Market Success in Pharmaceuticals: The Case of Cholesterol Ethical Drugs
Alan N. Afuah
What is the role of a drug’s technical performance as a driver of product market success? Are drug prices really rising as fast as they appear to? Are more expensive drugs really more effective? This paper uses cholesterol drugs to examine these questions. The results suggest that: 1) Quality adjusted prices are lower than the unadjusted ones — an annual increase of 6% compared to 9% when unadjusted for the years 1986 to 1992; 2) Expensive drugs tend to be more effective; and 3) Technically superior drugs tend to be more successful in the market; the better the performance characteristics of a drug, the more successful it is in the market. The technological generation from which a drug comes — a proxy for the characteristics of the drug – also has a significant effect on the drug’s market success.

POPI WP #2-92
Auditing the Producer Price Index: Micro Evidence from Prescription Pharmaceutical Preparations
Ernst R. Berndt, Zvi Griliches & Joshua G. Rosett
From January 1984 through December 1989, the Bureau of Labor Statistics (BLS) price index for prescription pharmaceuticals grew at 9.09% per year. Using BLS-type Laspeyres index procedures with monthly price and quantity data on all prescription pharmaceuticals sold by four U.S. pharmaceutical manufacturers accounting for 24% of industry domestic sales, we find that the four-company index increases at 6.68% per year. When we employ a Divisia price index with smoothed weights incorporating new goods, the index grows 6.03% per year. Why does the BLS index grow 50% more rapidly than the Divisia index? That mystery is the focal point of our article.

POPI WP #1-92
Cost of Capital Estimates for Investment in Pharmaceutical Research and Development
Stewart C. Myers & Lakshmi Shyam-Sunder
This paper summarizes what modern finance can say, using publicly available data, about the cost of capital for investment in pharmaceutical R&D. It provides benchmark estimates for 1980, 1985, and 1990, and discusses how the estimates could change under different assumptions about financing and risk. It also discusses some of the practical difficulties encountered in evaluating commitments to R&D programs. The paper is an overview of standard theory and good current practice on these topics. The standard theory is briefly reviewed in the next section. Section 3 gives preliminary estimates of the overall cost of capital for major U.S. pharmaceutical companies. Current practice would use these estimates as benchmarks, adjusting them up or down to set the cost of capital and discount rate or “hurdle rate” for particular classes of capital investments. This section also comments on cost of capital estimates used in past studies of costs and returns in pharmaceutical R&D. Section 4 discusses the special risks that could justify a cost of capital for pharmaceutical R&D higher than the benchmark overall cost of capital for major pharmaceutical companies. We note some of the practical problems encountered in evaluating investments in pharmaceutical R&D. For example, the skewed payoff distributions encountered in R&D investments often make application or interpretation of standard discounted cash flow analysis exceptionally difficult.