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The effect of purely persuasive advertising on generic market entry and social welfare is analysed. An incumbent has the possibility to invest in advertising which affects the prescribing physician's perceived relative qualities of the brand-name and the generic version of the drug. Advertising creates product differentiation and can induce generic market entry which is deterred without differentiation due to strong Bertrand competition. However, over-investment in advertising can deter generic market entry under certain conditions and reduces welfare as compared to accommodated market entry.

Since patients are uninformed and lack the information about which treatment is most effective, they depend on physicians who diagnose and suggest some treatment. Therefore, physicians directly affect the extent of competition between different providers of a treatment and they can be taken as the main determinant of whether a brand-name or a generic drug version is prescribed. This is in line with the empirical evidence in Hellerstein (1998). Hence, it is not surprising that in the pharmaceutical market, where price competition would be fierce, if the products were not differentiated somehow, the physician is the target of huge advertising expenditures. Advertising expenditures with about 20–30% of sales are often even larger than those for R&D (Hurwitz and Caves (1988)). Jacobzone (2000) shows that within the OECD countries, the research-oriented pharmaceutical firms spent 24% of sales on marketing in 1989. And Scherer (2000) reports that in the United States, the ethical pharmaceutical industry spent 18% of sales on marketing in 1997. Advertising in the ethical pharmaceutical market is in general allowed, if targeted towards experts, i.e. the physicians, on the grounds that it provides necessary information which might dominate the downsides of advertising. This paper, however, emphasises the persuasive aspect of advertising and thus the ‘negative’ aspect of advertising and shows that, as in the literature on informational advertising1, advertising per se is no barrier to market entry. The advantage of persuasive advertising, namely product differentiation which induces generic market entry and thus lower post-patent prices, can dominate the negative effect due to brand-loyalty, if an upper limit of advertising is not surpassed. It is analysed under which circumstances generic market entry is most likely and how these conditions can be positively influenced by the health authorities.

This paper is concerned with a pharmaceutical market in which, after the expiry of a patent, the incumbent faces the threat of generic market entry. During patent life, the incumbent has the possibility to invest in advertising targeted at the prescribing physician with the effect that the brand-name drug's perceived quality is increased and differentiated from the generic drug's quality. On the one hand, this is an important precondition for generic market entry, on the other hand, generic market entry can be deterred by over-investing in advertising. Detailing in the pharmaceutical market is in general allowed, because it is assumed that it is mostly informative. Hence, the positive effects of a better matching between patients and drugs dominate the negative effects attributed to persuasive advertising. The analysis showed, however, that there are some positive welfare aspects with respect to even persuasive advertising in the sense that generic market entry can be induced and post-patent prices are lower. Hence, against first intuition, the persuasive effect of advertising does not necessarily decrease the welfare benefit of advertising due to information, but can even reinforce it under certain circumstances. This is particularly true for a short period of patent protection, for an inexpensive and a ‘not-too-ineffective’ advertising technology, and low market entry costs. Hence, these are the parameters that a regulator should try to manipulate in order to ensure generic market entry and to maximise welfare.