US Pharmaceutical Industry - Porter's 5 forces analysis

The U.S. Pharmaceutical Industry

        1)  Threats of entry posed by new or potential competitors – LOW 
  • High barriers to entry; the company needs to put a lot of capital into research and development, lengthy approval process, marketing before it is able to receive any returns. 
  • The “big pharma” companies that were able to build global operations are benefiting from economies of scale in terms of manufacturing. They are able to access low-cost supplies, as a result. 
  • Challenging regulatory conditions (hurdles to get FDA drug approvals for new products); industry is highly regulated which to some extend protects from new competition. The FDA approvals appear to have slowed during 2007. This could be one measure indicating that the FDA is taking a more cautious position on new drug approvals. In addition, legislative changes in the upcoming years may have a negative impact for the industry.
  • Pharmaceutical companies benefit from continuation of U.S. employer-based health coverage. Customers buy medication that was prescribed by the doctors. 
  • Patent expirations may lead to an entry of new competitors (generic competitions), resulting in decreased revenues. High rates of patent expirations are approaching in 2010 through 2012. 
  • The ability of a pharmaceutical company to offset loss of revenue from patent expirations depends on growth in existing products as well as successful execution from the new product pipeline.
     2)  Degree of rivalry among existing firms - HIGH
  • Mature, consolidating, highly competitive industry (many large pharmaceutical acquisitions closed in 2007 including AstraZeneca’s $15.6Bn purchase of Medlmmune Inc. and Schering-Plough’s $15Bn acquisition of Organon BioSciences).
  • Strong credit profiles: companies operate off of high margins (high 70%), healthy balance sheets, and good liquidity
  • Industry benefits from strong demand from consumers.
  • Weak, small companies usually go out of business (bankruptcy) if they have no potential “blockbuster” in future pipeline. Others that have some significant research or valuable assets will be bought by big and strong pharmaceutical companies. 

     3)  Bargaining power of suppliers - LOW
  • Suppliers generally have little room for negotiation. Large pharmaceutical companies generally enjoy significant buying power. They can dictate the price they want to buy or take their business elsewhere. 
    4)  Bargaining power of buyers - LOW
  • Generally consumers have very little bargaining power. Most of the medication is prescribed by the doctors. Consumers will have to buy the drug at any given price if they need it. More educated consumers may buy a generic alternative (which have the same impact but less expensive) if available on the market. 
  • Pricing pressure – The U.S. remains one of the few developed markets where drug manufacturers have significant pricing flexibility, and this is in jeopardy due to increasing pressures from consumers and legislators to control health care costs. Governments in other markets are generally the primary customers, and therefore, enjoy substantial pricing leverage.
  • Shareholders continue to pressure the companies for increases in the share repurchase programs. The companies looking for ways to increase shareholders returns partly because the industry is approaching maturity and is not growing as rapidly, and because many companies have a lot of cash on their balance sheet. 
    5)  Closeness of substitute products – MEDIUM
  • Threat from generic competition.
  • Customers can find substitute medicine if the original product has an expired patent. However, if it is a new product the consumer generally will have no choice for an alternative.
  • Over the few years generic drug manufacturers face excellent opportunities for utilization and volume trends. Generic companies are increasing focused on establishing global operations in order to achieve a lower-cost of supplies, thus posing even more threat to non-generic drug manufacturers. 

Based on Porter’s model LOW to MEDIUM forces are present among the strong players in the pharmaceutical industry. Thus, the industry is attractive to investors largely due to the high-barriers to entry, purchasing and pricing power, and strong credit profiles of existing firms.