Entry Pricing and Product Quality: The Case of Antidepressant Drugs

The rising prices of pharmaceuticals have generated considerable, and often acrimonious, debate. Yet, there is little theoretical work or empirical evidence on pharmaceutical entry-pricing strategies or on the time paths of the prices of new entrants versus incumbents. This study explores the entry pricing strategies of pharmaceutical manufacturers. Previous theoretical models have considered a “price skimming” strategy, with drugs entering the market at a premier relative to incumbents or a “market penetration” strategy, pricing the drug at a discount in the hope of gaining market share. The selection of appropriate strategy depends upon the degree of product differentiation and/or the nature of repeat purchase arrangements. However, these investigations have not examined the implications of product quality for entry pricing and pricing dynamics. The present study provides a model that demonstrates the interplay between quality and product differentiation in determining the optimal pricing strategy. In particular, higher (lower) quality products will engage in price skimming (market penetration) strategies in markets where products are sufficiently differentiated, but will choose a market penetration (price skimming) strategy in markets that are less differentiated. The reason is that in less differentiated markets, price competition is more important than quality competition for gaining market share and higher-quality firms are better able to garner greater market share through price cuts. We tested this model using a unique database that combines information on drug price and quality for antidepressant drugs during the years 1999-2002. Based on quality perceptions by physicians, the antidepressant market we examine is a relatively homogeneous drug class, which consisted largely of selective serotonin reuptake inhibitors (SSRIs). The results indicate that higher quality antidepressants engage in a market penetration strategy, charging initially lower prices that rise over time. Five years post-entry, we find that prices of all antidepressant drugs examined tend to converge. These findings are consistent with a market in which product differentiation is modest and consumers learn which drug works best for them through experience. JEL Classification: I110, L100, L110