Managers in the pharmaceutical industry face both opportunities and threats due to a dynamic environment. Demand for pharmaceuticals has grown steadily for decades due to demographics and successful new drugs can be highly profitable. However, developing new drugs takes 10-15 years and costs $800 million on average, with many failing. Additionally, incumbent firms face challenges such as upcoming patent expirations, potential price controls, and reduced prices negotiated by large health providers.

1. Managers in pharmaceutical firms face a dynamic and challenging task
environment that creates both opportunities and threats. Demand for
pharmaceuticals is strong and has been growing steadily for decades
Managers in pharmaceutical firms face a dynamic and challenging task
environment that creates both opportunities and threats. Demand for
pharmaceuticals is strong and has been growing steadily for decades
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General Management
CASE: 1 THE PHARMACEUTICAL INDUSTRY
Managers in pharmaceutical firms face a dynamic and challenging task environment
that creates both opportunities and threats. Demand for pharmaceuticals is strong
and has been growing steadily for decades. Between 1990 and 2005 there was a 12.5
percent annual increase in spending on prescription drugs in United States. The
strong growth was driven by demographics. As people grow older they tend to
consume more prescription medicines, and the population in most advance nations
has been growing older as the post – World War II baby boom generation ages.
Moreover, successful new prescription drugs can be extraordinarily profitable.
Consider Lipitor, the cholesterol-lowering drug sold by Pfizer. Introduced in 1997, by
2005 this drug generated a staggering $12 billion in annual sales for Pfizer. The costs
of manufacturing, packaging, and distributing Lipitor amounted to only about 10
percent of revenues, or around $1.2 billion. Pfizer spent close to $400 million on
advertising and promoting Lipitor and perhaps as much again on maintaining a sales
force to sell the product. That still leaves Pfizer with a gross profit from Lipitor of
perhaps $10 billion.

2. Lipitor is highly profitable because the drug is protected from direct
competition by a 20-year patent. This temporary monopoly allows Pfizer to charge a
high price. Once the patent expires, other firms will be able to produce generic
versions of Lipitor, and the price will fall—typically by 80 percent within a year—but
that is some time away.
Competing firms can produce drugs that are similar (but not identical) to a
patent-protected drug. Drug firms patent a specific molecule, and competing firms
can patent similar, but not identical, molecules that have a similar pharmacological
effect. Thus Lipitor does have competitors in the market for cholesterol-lowering
drugs—such as Zocor, sold by Merck, and Crestor, sold by AstraZeneca. But these
competing drugs are also patent protected. Moreover, due to Federal Drug
Administration regulations and requirements for demonstrating that a drug is safe
and effective, the cost and risks associated with developing a new drug and bringing
it to market are very high. Out of 5,000 compounds tested in the laboratory by a drug
company, only five enter clinical trials, and only one of these will ultimately make it
to the market. On average, estimates suggest that it costs some $800 million and
takes anywhere from 10 to 15 years to bring a new drug to market. Once on the
market, on the market, only 3 out of 10 drugs ever recoup their R&D and marketing
costs and turn a profit. Thus the high profitability of the pharmaceutical industry
rests on a handful of blockbuster drugs. To produce a blockbuster, a drug company
must spend great amounts of money on research, most of which fails to produce a
product. Pfizer, for example, spent over $7.4 billion on R&D in 2005 alone,
equivalent to 14.6 percent of its total revenues.
In addition to R&D spending, the incumbent firms in the pharmaceutical
industry spend much money on advertising and sales promotion. Although the $400
million a year that Pfizer spends promoting Lipitor is small relative to the drug’s
revenues, it is a large amount for a new competitor to match, making market entry
difficult unless the competitor has a significantly better product.
There are also some big opportunities on the horizon for firms in the industry.
new scientific break-throughs in genomics portend that within the next decade
pharmaceutical firms might be able to bring new drugs to market that treat some of

3. the most intractable medical conditions, including Alzheimer’s, Parkinson’s disease,
cancer, heart disease, stroke, and HIV.
On the other hand, managers in the industry face serious challenges. Many
patent-protected medicines are scheduled to come off patent in the next decade, and
to maintain profitability, pharmaceutical firms must find new drugs to replace them.
In addition, as spending on health care rises, seniors are complaining about the high
costs of prescription medicines, and politicians are looking for ways to limit this. One
possibility is some form of price controls on prescription drugs. Pharmaceutical price
controls are already in effect in most developed nations, and although they have not
yet been introduced in the United States, that could happen. Another possibility is to
make it easy for U.S. residents to purchase pharmaceuticals from foreign nations
where prices are lower.
A further challenge is associated with the growth of large health care providers,
who have millions of subscribers and are starting to use their power to reduce the
drug prices their subscribers pay. In some cases they are refusing to provide
insurance coverage for high-priced pharmaceuticals when lower-priced generic
alternatives are available.
Questions
1. What are the barriers to entry into the pharmaceutical industry? To what
extent do you think these entries barriers protect established pharmaceutical
companies from new competitors?
2. The pharmaceutical industry has long been one of the most profitable in the
United States. Why do you think this is the case?
3. What forces in the general environment influence the nature of competition
in the task environment facing pharmaceutical firms?

4. 4. Are there reasons for believing that the profitability of the industry might come
under threat over the next decade? What do you think managers in the industry
should do to counter this threat?
Assignment Solutions, Case study Answer sheets
Project Report and Thesis contact
aravind.banakar@gmail.com
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