Strategic Entry Deterrence and the Behavior of Pharmaceutical Incumbents Prior to Patent Expiration

The insight that firms may make “strategic investments” to alter future competitive conditions is one of the most fundamental ideas in industrial organization. Jean Tirole’s (1988) chapter reviewing arguments about how excess capacity, capital structure, advertising, contractual practices, learning-by-doing, and other actions can be used to deter entry is easily the longest in the text. Strategic investment models are difficult to test directly, however, and the vast majority of this literature is theoretical. In this paper, we propose a new empirical approach for examining strategic entry deterrence. Our applied focus is on the pharmaceutical industry. Using a panel of drugs that lost their US patent protection between 1986 and 1992, we explore how pharmaceutical incumbents have dealt with the threat of generic entry. We examine incumbents’ advertising, product proliferation, and pricing decisions as patent expiration approached, and ask whether the behaviors appear to be influenced by an entrydeterrence motive.