Power Play

Market competition requires a balance of power between buyers and sellers.

Although U.S. drug companies sell many drugs, its major revenue generators come from a few patented blockbuster drugs. On-patent drugs can command very high prices because no other companies are allowed to compete with them using bio-equivalents. In the good old days, drug companies could still retain a sizable market share even for drugs with expired patents. Cheaper generic equivalent drugs could not be marketed until they went through time-consuming clinical trials as if they were new drugs. The Hatch-Waxman Act of 1984 reduced the amount of testing required for generic bioequivalent drugs. Generic drug companies simply had to show that the generic is absorbed in the blood stream in the same fashion as the name brand (San Francisco Chronicle 6/24/02). Within a year of the bill's passage, 9 of the industry's 10 best-selling drugs had new generic rivals (WSJ 4/18/02).

But patients could not opt for cheaper generic drugs if their doctors didn't prescribe them. And generic drug companies with narrow profit margin could not afford to pitch generic drugs to doctors. So doctors simply switched to other equally expensive competing brand-name drugs heavily promoted by their salesmen when the patent of one drug expired. Brand-name drug companies losing sales from off-patent drugs could also raise prices for other on-patent drugs to recoup their losses. The bottom line was that individual patients paying out-of-pocket for their prescription drugs did not get the full benefits of cheaper generic drugs.

To make the generic drugs more competitive with brand-name drugs, drug buyers had to get organized to demand cheaper generic drugs. The rise of managed health care plans in the early 1990s that included drug benefits for a fixed per-patient premium provided such a countervailing power. These large drug purchasers had enough buying power to demand not only price discounts for on-patent drugs. They also hired drug-benefits managers who pressured doctors affiliated with their health plans to switch to generic drugs wherever available.

The balance of market power finally tipped towards the generic drugs near the end the 1990s. When the patent for Prozac (an anti-depressant) expired in August 2001, generics took away 80% of the drug's new prescription sales within 2 months. Also, the growth of new prescriptions for each of Prozac's brand-name competitors fell by at least half.

Market competition does not require many small buyers and small sellers, but it does require that the balance of market powers between buyers and sellers be evenly matched. Big managed health care plans are worthy match for big brand-name drug companies. But the government's helping hand in the form of the Hatch-Waxman Act also has been indispensable in restoring the balance of power.