Pharmaceutical Regulation and Switching Cost: New Results in Old Skins

This paper analyzes the impact of a negotiated scheme and a generic reference price system in comparison to a simple copayment system in a vertical di¤erentiation model with switching costs. The duopolistic market structure with an o¤-patent brand-name drug competing in a Stackelberg-mode with a generic version is adopted from Merino-Castéllo 2003. Brand-name drug and generic version di¤er in perceived quality. This framework is extended by a …rst-mover advantage due to switching costs as speci…ed by Schmalensee 1982: Pre-purchase-uncertainty concerning the generics’quality results in a reduced willingness to pay and thus forces the imitator to o¤er a discount to attract consumers, whereas uncertainty no longer applies to the o¤-patent brand-name drug in the duopolistic period considered here. Switching costs are of fundamental importance in pharmaceutical markets and provide an explanation for observations of the so-called "generic paradoxon". Consequently, two opposed e¤ects on the brand-name drug can be observed: Whereas price regulation whether due to a reference price system a negotiated scheme leads to a disadvantage for the brand-name drug, uncertainty regarding the properties of the generics results in an competitive advantage for the brand-name drug. JEL Classi…cation: I18, I11, L50, H51