- 1. Drawing on the five forces model, explain why the pharmaceutical industry has historically been a very profitable industry?
Porter’s Generic Five Forces Model (Exhibit 1)
Buyers Bargaining Power
Buyers bargaining power in the pharmaceutical industry was low because there were only a few good and well-known companies, who were the sole manufacturers of some prescription medicines. These medicines were protected by patents therefore; no other company was able to manufacture generic drugs on the same formula. This restricted the buyers of this industry from opting to other companies and as a result, companies sold their prescription drugs at premium prices. Spending on prescription drugs was increased because of the increase in older age population. For example, Pfizer was the only company at that time that had a patent protection for a cholesterol controlling drug and customers were compelled to purchase that drug because of unavailability of identical generic drugs.
Supplier’s Bargaining Power
Supplier’s bargaining power was low because a drug manufacturer needed to have different components for manufacturing a particular drug. Suppliers were unaware about the exact formula which had reduced their power.
Threat of Substitute
Threat of substitute was very low because every big company had protected its prescription drugs by patents and its competitors were unable to produce the same formula to substitute the drugs. This also enhanced the degree of competition and made the industry so successful for the leading firms.
Threat of New Entrants
Threat of new entrant was also low because of the high start-up costs and high costs and risk associated with the manufacturing of new drugs. Out of every 5,000 tested compounds in a laboratory of a pharmaceutical company, only five of them enter into clinical trials and only one get an approval from the FDA to make its way to the market.
Industry Rivalry
Industry rivalry was moderate because prior to 2002, the industry was dominated by a few drug manufacturers and one of them was Pfizer. Pfizer was the leading brand and it had generated 55% of its revenues from just eight drugs.
After analyzing different forces of the pharmaceutical industry, it is clear that the industry has been historically profitable because almost all the forces of the industry are low, which have created a very powerful and effective environment for the existing firms.
- 2. After 2002, the profitability of the industry, measured by ROIC started to decline. Why do you think this occurred?
In 2002, the ROIC in the pharmaceutical industry was 21.6% because the industry condition was very favorable due to the increase in the demand for prescription drugs, less health concern from the government and low competition. The industry was dominated by the Pfizer and it had eight leading drugs, which was protected by patents. Moreover, the demand for prescription drug was..........................
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