Generic drug firms deter entry by lowering price

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In a recently published article, we discuss our finding that generic drug companies successfully use low-pricing strategies to discourage entry by new competitors in certain circumstances. We identify the effect of potential competition using a unique feature of a federal law that regulates drug competition, commonly referred to as the “Hatch-Waxman Act.” Under certain conditions, Hatch-Waxman awards 180 days of marketing exclusivity to the first generic firm filing for FDA approval, temporarily protecting the FDA-designated incumbent from entry by other generic competitors.

We compare generic drug prices in the exclusivity period to generic drug prices in the following period, when Hatch-Waxman no longer prohibits entry. The analysis controls for other factors that vary between the two periods, including the number of actual competitors. Because the remaining difference between the two periods is the ability of other generic firms to enter, lower prices outside of the exclusivity period are interpreted as a response to potential competition, or “entry threats.”

The results show that generic drug companies’ responses to potential competition vary by the market size of the drug. In drug markets with lower dollar sales, incumbents employ a strategy of reducing price in response to an increase in potential competition. This price reduction is an effective entry deterrent. In drug markets with higher dollar sales, however, the incumbent accommodates entry by lowering price only after competing manufacturers enter the market. This pricing strategy leads to a significant increase in the number of generic competitors after the Hatch-Waxman exclusivity period ends. Overall, the paper shows that price can be an effective entry deterrent in certain circumstances where the cost of deterring entry is not too high.

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