Switching Costs, Brand Premia and Behavioral Pricing in the Pharmaceutical Market

Abstract

This article examines the market power of branded prescription drugs faced with generic competition. Using prescription-level and matched socioeconomic panel data of the entire Swedish population between 2010 and 2016, I provide evidence for the key role of switching costs. A discontinuity surrounding patent expirations establishes that the effect is causal. Further, by comparing patients with and without medical education, I show that those without medical education experience higher brand premia. A unique feature of the Swedish market allows me to rule out patients' inattention due to information costs as a source of market power. Therefore, switching costs and perceived quality differences are the key determinants of market power. I then estimate a dynamic oligopoly model with forward-looking firms which is used in counterfactual studies of the effect of switching costs and perceived quality differences on prices. First, an increase in the length of procurement mimics a reduction of switching costs and increases prices. While the effect of switching costs on prices in theory is ambiguous, moderate switching costs and sufficient competition for new patients increase competitive pressure. Second, if everyone acts as a medical expert and experiences fewer brand premia, prices decrease.

The Roots of Health Inequality and the Value of Intrafamily Expertise

“… Similarly, Bronnenberg et al (2015) andJanssen (2018) provide evidence on how expert knowledge affects individuals' willingness to pay for branded versus genetic pharmaceuticals.9 McCrary and Royer (2011) also establish a positive effect of maternal education on infant health. Further, Lundborg and Majlesi (2018) exploit a Swedish compulsory schooling reform to document spillovers in the opposite direction, from children's education to parental longevity.…”

A New Approach to Estimating State Dependence in Consumers’ Brand Choices Applied to 762 Pharmaceutical Markets*

“…A third contribution is that the article separates state dependence for individual pharmaceutical brands from heterogeneity that cannot be captured by observables. This complements the work by Feng [2018] and Janssen [2019] by, instead of producing reduced form evidence on state dependence in the dichotomous choice between the brand‐name product and any generic version, estimating state dependence effects on the product level. Compared to Janssen's structural estimation, the contribution of this article includes that it analyzes state dependence on the product level for a large set of drugs (762 exchange groups) and uses instruments to separate state dependence from inertia caused by uncontrolled heterogeneity.…”

“…In using this quasi‐experimental approach to identify state dependence, this article relates to Ericson [2014], who used an experiment in which plans for the Medicare Part D Low‐Income Subsidy Program were randomly assigned. It also relates to Coscelli [2000], Iizuka [2012], Chan, Narasimhan and Xie, [2013], and more closely to Feng [2018] and Janssen [2019], who all found inertia in choices among pharmaceuticals. Coscelli [2000] used patients’ switching of physicians to conclude that inertia at the patient level contributed to patients’ being prescribed the same drug repeatedly, even though therapeutic alternatives exist.…”

“…Similarly, Chan, Narasimhan and Xie, [2013] found significant switching costs among therapeutic alternatives. Feng [2018], using U.S. data, and Janssen [2019], using Swedish data, analyzed how state dependence affects which pharmaceutical is bought. Feng used variation in the availability of alternatives when patients started treatment as an instrument to study state dependence in choices between therapeutic alternatives and between brand‐name and generic pharmaceuticals on reduced form.…”

The Importance of the First Generic Substitution: Evidence from Sweden

“…Health economic studies in multiple countries have concluded that patients prefer originals and experience history dependence when choosing pharmaceuticals, meaning that they tend to consume products with which they have had a positive experience (Bronnenberg et al, 2015;Feng, 2020;Granlund, 2021;Janssen, 2020). 3 We add to the literature but also highlight that it is possible to break such history dependence.…”