Price relative to competition: the case of the pharmaceutical industry in Spain.

ABSTRACT

It is accepted that the power of a firm to set up the price for a product above the average price of competitors and to get the acceptation of consumers reflects the superiority of this particular product and, thus, its competitive advantage. This paper tests the hypothesis that the firm ' external and internal factors affect its chances to set a price above the average price of competitors. From a sample of 200 pharmaceutical drugs we find that consumers accept paying an extra price for brands with a larger number of strengths, in early stages of life cycle position, and consumer loyalty and brand image.

INTRODUCTION

The question of why firms pursue different strategies or how firms achieve and sustain competitive advantage has been answered using different theories and approaches (Hoskisson, Hitt, Wan y Yiu, 1999). Industrial Organization Economics and Porter's contributions (1980, 1985, 1986) explain the ability for a firm to gain competitive advantage based mainly on how well it positions and differentiates itself in an industry. And as a refinement of the traditional S-C-P paradigm (structure-conduct-performance), Porter's framework specifies the competitive structure of an industry in a more tangible manner, as well as recognizes (albeit limited) the role of firms in formulating appropriate competitive strategy to achieve superior performance (Hoskisson, Hitt, Wan y Yiu, 1999, p. 426).

The New Institutional Economics gives us the possibility to introduce the rest of the external conditions that affect firm's strategies, that is the institutional environment (the set of fundamental political, social and legal ground rules that establishes the basis for production, exchange, and distribution). For some industries, like the pharmaceutical, the regulation as a part of the institutional environment has to be not just considered but introduced by firms into their strategies in order to achieve competitive advantages.

Those arguments above allow us to present the model in which we consider the factors that influence price decisions and, thus, a competitive advantage for the firm. Next, we develop the relationships described in the model (figure 1).

[FIGURE 1 OMITTED]

THE DETERMINANTS OF THE PRICE RELATIVE TO COMPETITION (PRC)

An external competitive advantage of a product/brand is concerned with those distinctive attributes which provide value to a buyer and allows a firm an edge over its adjoining competitors. Porter defines this advantage in terms of a firm's ability to price higher than the competitors' average price (Porter, 1980). Then, the price relative to competition ratio (PRC), which is defined as the quotient between a firm's product price (Pi) and the average price of its identical competitors (PIC), is a proxy of the competitive advantage of a product relative to the market participants.

To answer the question of why a firm can price higher than its competitors, it is necessary to consider in greater depth those factors related to the PRC of a product. For this purpose, we analyse the following concepts: first, the depth of a brand and scope of the product portfolio and the position of a product within the life cycle (product decisions).

We add public regulation (institutional environment) for each product considering the important regulatory constraints related to the pharmaceutical industry. In particular, the Spanish pharmaceutical market exhibits several specificities that influence the way that pharmaceutical laboratories define their price strategies. On the one hand, we include public regulation as an additional issue that affects price strategies since the upper limit for pharmaceutical drug prices is set by the Ministerio de Sanidad (Health Department). On the other hand, pharmaceutical demand is price-insensitive, both because the patient does not select the drug he or she will consume--instead the physician picks the drug therapy and also chooses either the brand or generic form- and because the patient often does not pay the full price--pharmaceutical drugs, like most other transactions in the health system, are third-party covered and directly provided by the state.

Depth of the Brand, Scope of the Firm Portfolio and PRC

Usually, firms do not pursue single-product strategies but multiple-product strategies. To satisfy a single need, a firm with a deep brand and a large scope portfolio will be better suited to specific segments of the market needs (Kadiyali et al., 1999). As a consequence, a firm is able to set a higher price than competitors as the utility of diversity is …