Studies in Income and Wealth
`Volume 58
`
`. . . . . . 8(<tl'fttGITftOtmm.
`MilER lfiODUOION, W/0 PERMISSIOM, IS PROHIBIT
`
`Th~ Economics of
`New Goods
`
`Edited by
`
`Timothy F. Bresnahan and
`Robert J. Gordon
`
`-'
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`National Bureau of Economic Research
`Conference on Research in Income and Wealth
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`• c~ ·: .. , .... . r.
`The University of Chicago Press ..
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`Chicago and London
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`SENJU EXHIBIT 2151
`LUPIN v. SENJU
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`276
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`Robert C. Feenstra and Clinton R. Shiells
`
`(2) if price is mismeasured, so is the dependent variable, but then their formula
`for the coefficient becomes ( f3 + 1 )(a -
`I ) , and the implied a = 1.2 is even
`less credible.
`"Aging of lines": Once popular restaurants lose customers over time. We
`could bring in new ones and make an adjustment for their superiority. But then,
`some time later, the chefs are hired away and the old restaurants regain their
`share. Will we come back to the same level? How?
`A major finding is that if one allows for the changing mix of import goods
`this leads to lower estimates of their income elasticity. That makes sense, but
`how low ·'should" the import income elasticity be? Can one really explain
`rising world trade just by the reduction in transport costs and the rising quality
`of traded goods? I find the notion that traded goods have higher income elastic(cid:173)
`ities quite plausible. The explicit "bias" adjustment to the price index that fol(cid:173)
`lows is, however, more problematic. But the advice to collect more data is
`surely right!
`
`References
`Berty, S. T. 1994. Estimating discrete-choice models of product differentiation. Rand
`Journal of Economics 25, no. 2 (summer): 242-62.
`Griliches, Zvi, and lain Cockburn. 1994. Generics and new goods in phannaceutical
`price indexes. American Economic Review 84 ( 5 ): 1213-32.
`Hanoch, Giora. 1971. CRESH production functions. Econometrica 39 ( 5 ): 695-712.
`Trajtenberg, Manuel. 1990. Product innovation, price indices and the ( mis-)
`measurement of economic performance. NBER Working Paper no. 3261. Cam(cid:173)
`bridge, Mass.: National Bureau of Economic Research.
`
`I
`
`~--=--
`/ fiWliB ilfPIOOimJN, W/O#IS PiOHI8fTED
`The Roles of Marketing, Product
`Quality, and Price Competition
`in the Growth and Composition
`of the U.S. Antiulcer
`Drug Industry
`Ernst R. Berndt, Linda T. Bui, David H. Lucking· Reiley,
`and Glen L. Urban
`
`7
`
`-~
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`7.1 Introduction
`The introduction ofTagamet into the U.S. market in 1977 marked the be~:; :.:
`;· ,
`ning of a revolutionary treatment for ulcers and the emergence of a new indlJ!: ~ ' '. · . ~-. ~­
`try. What distinguished the products of this new industry was their ability,!q; ~~: ·~
`heal ulcers and treat preulcer conditions pharmacologically on an outp~~iil-'2 :~:;, · •'. ..
`basis, thereby substituting for traditional, and costly, hospital admissions~~·~'-·" ..
`surgeries. Tagamet, known medically as an H2-receptor antagonist, promo~~\G/ ··· ·- ~·
`the healing of ulcers by reducing the secretion of acid by the stomach. . .. . , ,{;·~':;;(
`A striking feature of the antiulcer market is that it has sustained growthW' : _;
`' '
`sales (quantity, not just revenue) for over fifteen years and still shows n<>. ·:· ·•··, g; t; ~ ;
`it ';;; , .
`of slowing. New prescribing habits have clearly diffused to an ever iricre' .,
`number of physicians. Today there are a total of four H2 receptor antagopi,~~tkf·a'i,:i: ;,; .~
`Tagamet, Zantac, Pepcid, and Axid. Zantac is now the United States' (and.:the.:.' ;{;):~'
`/ -·
`world's) largest-selling prescription drug, having estimated worldwide:s~~if('~~;·;,{~t ~:
`in ~992 of a~ou_t $3.5 bill!on. Mor~over, Tagamet is also among the tei\_I~ii;~· .• }i1:· f:, '
`selhng prescnptton drugs m the Umted States.'
`
`· -·'-~:x,t·<: F ·:;:
`: :??~-fr:·:?:o ~,' -~~--
`.;
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`, .
`• _____ r'":-
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`
`Ernst R. Berndt is professor of applied economics at the Sloan School of Management ·· ·
`Massachusetts Institute of Technology. Linda T. Bui is assistant professor of economics at B
`University. David H. Lucking-Reiley is assistant professor of economics at Vanderbilt Uni..
`Glen L. Urban is professor of marketing and dean of the Sloan School of Managemeil! .,
`Massachusetts Institute of Technology.
`Financial support from the Alfred P. Sloan Foundation is gratefully aclcnowledged,· -
`data suppon of Stcpben C. Chappell, Nancy Duckwitz, and Richard Fehring at IMS lnte_
`and Joan Curran, Marjorie Donnelly, Phyllis Rausch, Ditas Riad, Paul Snydennan, and J . ,,
`lowe at Merck & Co. The authors have also benefited from the research assistance of Adi'·" '
`Amit Alon, Ittai Hare!, Michele Lombardi. and Bonnie Scouter, and from discussions with\
`Bresnahan, Stan Finkelstein, M.D., Valerie Suslow, and Stephen Wright, M,D.
`·
`1. One hundred powerhouse drugs (1993, Sl). Incidentally, Thgamct ranks 7th, Pepcid l
`Prilosec 25th, and Ax:id 6lst in terms of U.S. sales. In terms of world sales,'Tagametis 7t:h;-p,''
`22d, Prilosec 49th, and Axid 67th.
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`E. R. Berndt, L. T. Bui, D. H. Lucking-Reiley, and G. L. Urban
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`The U.S. Antiulcer Drug Industry
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`•
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`by total industry patient-days, one would implicitly be assuming that the vari(cid:173)
`ous drugs a~e perfectly s~bst~tutable. To circumvent this problem, we employ
`t~e econom1c ~eory of pnce mdexes and calculate the industry price using the
`F1sher-Ideal pnce index. 14
`In terms of quality, to the extent that product-quality characteristics affect
`the size of the_ potential market, they should be included in an overall industry
`demand equation. We would expect that the size of the potential patient market
`would depend on the specific indications for which the FDA has granted
`approval. We shall concentrate on one particular indication, GERD, which
`represe~ted art espe~ially large potential new market, and for which the H
`-
`2
`antagomsts first received FDA approval relatively late in the sample. Specifi(cid:173)
`call~, when the FD~ granted approval to Glaxo's Zantac for GERD, Zantac
`?etaders were permitted to provide specific information to physicians concern(cid:173)
`Ing the_ ~eatment of GERD. This was significant, for instead of being confined
`to detatlmg to gastroenterologists who saw ulcer patients, now Zantac detailers
`also made calls on g~neral practitioners who commonly saw patients having
`GERD symptoms. Th1s undoubtedly expanded the potential market.
`Such reasonin~ suggests that a dummy variable, say, GERD (taking the
`value of 1 f?llowmg FDA approval), be employed in the overall industry de(cid:173)
`mand equatmn. Howev~r, it is worth noting that information concerning the
`efficacy of drugs for dtfferent indications typically diffuses prior to formal
`~A a~proval. The medical community is often aware of results of clinical
`tn~s.pnor to the_ FDA's reviewing the clinical-trial data and coming to a final
`deciS!~n. co~cermng approval for a new indication. As a result, a great deal of
`prescnbmg ts done off-label prior to the FDA's granting approval. Thus, it is
`not clear. how r~Iiable the GERD dummy variable wiH be in capturing major
`changes m the Size of the potential patient base.
`The thi~d set of factors affecting industry demand involves marketing ef(cid:173)
`~orts. Earher we noted that, in this industry, the two principal forms of market(cid:173)
`mg efforts are minutes of detailing and either pages or deflated dollars of medi(cid:173)
`cal journal advertising: There are several important issues concerning the
`measurem~n.t of_markett~g efforts. First, since drug marketing is largely a mat(cid:173)
`ter of provJ?J~g mforrnatwn about the existence and usefulness of the product,
`we expect Its tmpact to be long-lived; once a physician has been informed it
`is hard to s~e how ~~ch information might be destroyed. Indeed. precisely be(cid:173)
`cause ~f thts dur~bthty, firms typically expend a particularly large amount of
`marketmg_ effort m the ~arly stages of a new product's life. Hence the impact
`of marketmg on sales 1s likely better measured by the cumulative stock of
`marketing efforts since product launch, rather than simply by the flow of cur-
`
`14. Specifi~a!Jy, the Fisher-Ideal price index is the geometric mean of the Laspeyres and
`Paasche pnce mdexes, ":here e~ch o: the~ is computed using updated weights. New products are
`mcorporated as soon as IS feastble (t.e .• m the second period of their existence, so that their first
`dtfference IS calculille.d). For further details conceming the Fisher-Ideal price index see Diewert
`(1981. 1992).
`•
`
`rent monthly expenditures. We will also want to allow for the possibility that
`this stock of information depreciates or deteriorates over time, although we
`might expect the depreciation rate to be quite low.
`We therefore employ the well-known perpetual-inventory method. Let M, be
`the stock of marketing effort at the end of month t (as measured by the stocks
`of journal advertising and detailing minutes), let 8 be the monthly rate of de(cid:173)
`preciation of this stock, and let m, be the flow of marketing effort during time
`period t. Define M, as the depreciation-adjusted stock of marketing effort car(cid:173)
`ried over from the last month (I - 8 )M,_1 , plus new marketing efforts during
`months t (m,), that is
`M = (I - o) M + m = ~ ( I - o)'- T m .
`
`t
`
`"-
`T K
`
`I
`
`T
`
`(I)
`
`t
`
`r-1
`
`'
`
`We construct separate stock measures for detailing and for journal advertising.
`Unlike the typical case for capital-stock accounting, we have no problem wth
`establishing benchmark or "starting values" since we know that prior to August
`1977, the Tagamet journal (and detailing) stocks were zero. To implement
`equation (I), one must however assume rates of depreciation for each of these
`stocks. As discussed below. we will use the historical data on marketing and
`sales to estimate 8 econometrically, rather than assume its value a priori.
`The other major issue in measuring the effects of marketing efforts entails
`an innovation of this paper. Other authors have suggested that advertising be
`modeled as having two simultaneous effects in the market: overall advertising
`by all firms affecting overall market demand, and relative levels of advertising
`among firms affecting the individual firms ' market shares.1' We take this mod(cid:173)
`eling one step further here by hypothesizing that firms may choose to direct
`their marketing efforts to emphasize one of the two effects more than the other.
`Although the degree to which firms' marketing efforts are directed, say, at
`overall market expansion cannot be directly observed from data on quantities
`of marketing done by firms, we now propose a method for estimating this ef(cid:173)
`fect econometrically.
`To clarify this concept, we discuss it in the context of the antiulcer drug
`market. When SmithKline marketed Tagamet from its introduction in 1977
`until the entry of Zantac in 1983, they did not worry about competing for mar(cid:173)
`ket share in the H,-antagonist market, for patent status conferred on them a
`temporary monop~Iy position. From this monopoly position, the goal of mar(cid:173)
`keting for SmithKline was to convince more and more physicians of the utility
`of H2-antagonists in treating ulcer patients. They, and no other firm, reaped the
`rewards of having expended efforts on diffusing information on H2-antagonists
`to physicians, since they held 100 percent market share. However, once Zan-
`
`15. See, for example, Schmalensee (1972). There is a considerable body of literature on are(cid:173)
`lated. but distinct, approach that decomposes advertising into its "infonnation" and "persuasive"
`components. For examples in the context of the pharmaceutical industry, see Leffier (1981) and
`Hurwitz and Caves ( 1988).
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`E.R. Berndt, L. T. Bui, D. H. Lucking-Reiley, and G. L. Urban
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`The U.S. Antiulcer Drug Industry
`
`table 7.2 focus only on relative quantities (market shares), but leave fixed the
`size of total industry demand at, say, Q; denote these price elasticities bye~.
`A total-price elasticity also captures the impact of a product's price change ~n
`total industry demand; denote such a price elasticity by eJJ (no asterisk). As
`has been shown by, inter alia, Berndt and Wood (1979), the relationship be(cid:173)
`tween e;"j and eD is as follows:
`
`cumulative detailing or cumulative medical journal advertising is a more ap(cid:173)
`propriate measure of marketing impacts than are current monthly expendi(cid:173)
`tures. In the context of industry demand. we distinguish investments of finns
`in these marketing activities by the industry structure prevailing when the ~x­
`penditures originally occurred. In a monopoly market structure, all marketmg
`expenditures are market-expanding, for the monopolist has I D? perc~n~ ~arket
`share. In a market structure with k products, however, marketmg actlvthes be(cid:173)
`come more rivalrous, and as k becomes large, we expeci relatively little "spill(cid:173)
`over" of a firm's marketing efforts in affecting industry demand. We have hy(cid:173)
`pcthesized, therefore, that in terms of affecting industry demand, the relative
`effects of marketing expenditures originally made when k products were m the
`market will tend to decline as k increases. In other words, we hypothesize that
`the effectiveness of marketing in generating industry sales depends on market
`structure in a systematic manner.
`In our empirical analysis of the antiulcer drug market, we obtained consider(cid:173)
`able but not quite unanimous support for this hypothesis. In particular, nor(cid:173)
`malizing the impact of a monopolist's marketing investments on current sales
`to unity, we estimated the impact in a duopoly to be 0.6, in a three-product
`industry to be 0.8, and in a four-product market to he 0.5; these last three
`numbers are all statistically significantly different from unity (implying that
`we reject the hypothesis that the effectiveness of marketing efforts is indepen(cid:173)
`dent of market structure), and from zero (indicating that we reject the hypothe(cid:173)
`sis that once there is competition, the only impact of marketing is on market
`share, and there is none on overall market size). Thus our results suggest that
`in the antiulcer drug market there is clear evidence of spillovers~ and that these
`spillovers are considerably less than 100 percent effective. ~ore~ver, for ~e
`most part, these spillovers decline as the number of products m the mdustry In(cid:173)
`creases.
`Second, we find that at the industry level, both cumulative minutes of detail-
`ing and cumulative pages of medical journal advertising affect sales; typical
`estimates of these elasticities are 0.5 and 0.2, respectively. At the market-share
`level, relative sales of products are also positively related to relative cumulative
`minutes of detailing; this elasticity is typically in the range of 0.7 to 0.9. To(cid:173)
`gether these results imply that the marketing efforts of firms in the antiulcer
`drug market had substantial effects, in terms of affecting both market shares
`and the size of the overall industry.
`Third, a somewhat unexpected result we obtained is that at the industry
`level, the rate of depreciation of stocks of both minutes of detailing and medi'
`cal journal advertising was estimated to be ~ero. v:'e b.eh~ve that ~hiS·. re~ult
`reflects the fact that market-expanding marketmg pnmanly mvolves mformmg
`physicians about the usefulness of this class of drugs, and that once a physician
`begins prescribing these drugs, he or she is not likely to forget aboutotherr
`existence and stop prescribing them. By contrast, at the level.o_f.market shares.
`a rather different picture emerges. In particular, in the four-product market
`
`I
`
`(10)
`
`8 = e* 1
`_ + (alnQ1) (alnQ) ( olnP)
`,
`olnQ
`alnP
`olnP
`Q~Q
`
`H
`
`"
`
`j
`
`where Q1 is the quantity demanded of product j, Q is total industry demand,
`and Pis industry price. The first partial derivative in equation (10) can be
`assumed to equal unity (other things being equal, demand for product j grows
`equiproportionally with market demand, i.e., according to its market share),
`while the second partial derivative is the industry- or market-price elasticity
`(estimated values of which are given in table 7.1). The last partial derivative
`in equation (10) indicates the impact of a change in productj's price on the
`overall industry price index; it can be approximated by the revenue share of
`productj in total industry revenues.
`Alternative OLS and 2SLS estimates of e1~ are given in table 7.2, wh:ile NLS
`and NL-2SLS estimates of the industry-price elasticity are presented in table
`7.1. For the two-product market, 1993 drugstore revenue shares for Tagamet
`and Zantac are approximately 0.25 and 0.75. For the four-product market,
`these shares are approximately 0.19 (Tagamet), 0.60 (Zantac), 0.12 (Pepcid),
`and 0.09 (Axid). Together, these relationships imply that in the two-product
`context, the 2SLS estimates of the total own-price demand elasticities for Thga(cid:173)
`met and Zantac are approximately -1.154 and -1.690, respectively, while in
`the four-product market, the 2SLS estimated total own-price demand elasticity
`is -0.909 for Tagamet, -1.153 for Zantac, -0.820 for Pepcid, and -0.799
`for Axid. Note that while these point estimates imply that some of the demand
`elasticities are less than one in absolute magnitude~ the associated standard
`errors may well imply that reasonable confidence intervals include values of
`one and above (in absolute value).
`
`7.6 Concluding Remarks
`
`In this paper we have attempted to explain the phenomenal growth of the
`H2-antagonist antiulcer drug industry in the United States, as well as changes
`in the market shares garnered by the various products over time. Although we
`have examined the roles of product quality, order of entry, and price, we have
`focused particular attention on the role of various marketing efforts. Our
`framework and results can be summarized as follows.
`First, marketing efforts such as detailing and medical journal advertising
`have long-lived impacts. Thus, in explaining current-period sales, a stock of
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`E. R. Berndt, L. T. Bui, D. H. Lucking~ Reiley, and G. L. Urban
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`313
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`The US. Antiulcer Drug Industry
`
`(Tagamet, Zantac, Pepcid, and Axid), we find that the market-share impact of
`the stock of detailing minutes deteriorated at an annual rate of around 40 per(cid:173)
`cent, reflecting perhaps a more rivalrous content of marketing efforts.
`The remarkable growth in the market share of Zantac over time can be par(cid:173)
`tially explained, then, by the very substantial marketing efforts undertaken by
`Glaxo. However, pricing policies also had an impact. Zantac gained share over
`Tagamet in part because the price premium commanded by Zantac declined
`from about 56 percent in 1983 to only 25 percent in 1993. Our estimates of
`industry-price elasticities range from about -0.7 to -0.9, while estimates of
`cross-price elasticities between any pair of the four products are about 0. 7.
`Another set of important factors affecting sales of antiulcer drugs concerns
`product-qu,]ity attributes. At the industry level, the evidence suggests that the
`size of the market was enlarged considerably when the FDA granted approval
`for the GERD indication-a condition that occurs in a relatively large popula(cid:173)
`tion. At the market-share level, we find that when a product had a GERD(cid:173)
`approval advantage relative to other products, its market share increased. Thus
`another reason why Zantac fared so weU in the marketplace is that for quite
`some time it was the only product that had received FDA approval for the
`treatment of GERD. Another variable affecting market share significantly is
`the number of adverse interactions with other drugs reported to the FDA. On
`this accountTagarnet fared relatively badly (by 1993, Thgamet had twelve drug
`interactions, Zantac and Axid had only one, and Pepcid had none). Thus Zan(cid:173)
`tac aJso enjoyed advantages from this product-quality characteristic. An unex(cid:173)
`pected result we obtained, however, was that dosing frequency did not appear
`to affect market shares in a statistically significant manner.
`Finally, we found that, as in many other markets, order-of-entry effects are
`very substantial. In particular, holding constant price, marketing efforts, and
`product quality relative to the nth product, the ( n + I )th entrant can expect
`about forty percent lower sales.
`The results of this paper are of considerable interest in the current health(cid:173)
`care reform debate. Critics of the pharmaceutical industry have argued that
`much detailing is merely aimed at market share and is socially wasteful. Some
`have suggested placing ceilings on the marketing activities of pharmaceutical
`finns, but our findings demonstrate that this could have negative social welfare
`impacts. The findings in this paper suggest that marketing efforts also play a
`very important role in the diffusion of information to physicians, although the
`degree to which this is true probably declines somewhat as the number of prod(cid:173)
`ucts in a market increases. Moreover, our results suggest that in order to over(cid:173)
`come pioneer-product advantages. later entrants have found it necessary to
`advertise more intensively. An implication of these results is that if all pharma(cid:173)
`ceutical firms were constrained in their marketing activities, it is possible that
`the benefits would accrue primarily to the pioneer firms, at the expense of later
`entrants who would be prevented from trying to overcome pioneer-product ad-
`
`vantages. Thus. such a policy could have anticompetitive impacts, although it
`would be consistent with a patent system that rewards innovation.
`The research reported in this paper should be extended in a number-of ways.
`First, although the industry and market-share equations are plausible and pro(cid:173)
`vide important initial evidence on the roles of marketing, price, and product(cid:173)
`quality competition in the antiulcer market. the underlying mod~ls ~ould be
`modified in a number of useful ways. The most obvious extensmn ts to re(cid:173)
`formulate the models within an explicitly dynamic diffusion framework, such
`as those involving the Gompertz, logistic, or other more general diffusion(cid:173)
`curve formulations. In such a framework, marketing and pricing policies might
`not only affect the long-run or equilibrium level of demand, but they might
`also affect the speed at which a long-run equilibrium level is approached.
`As second useful extension would involve incorporating data on direct-to(cid:173)
`consumer marketing. In !988 SmithKline experimented with a "Tommy
`Tummy" television advertising campaign that was aimed directly at con~ume~s
`but did not mention Tagamet by name. More recently, Glaxo has adverttsed ~n
`magazines and on television, suggesting that patients with heartburn and actd
`discomfort should see their physicians. These ads are sponsored by the Glaxo
`Research Institute and, consistent with FDA regulations on direct-to-consumer
`advertising, do not mention the Zantac product by name unless the requisite
`warning and other product information is also fully disclosed. Since these ad(cid:173)
`vertisements typically do not mention products' names, their Impact IS more
`likely to be on industry demand than on market share. Moreover, direct-to(cid:173)
`consumer advertising may change the physician-patient infonnation-sharmg
`relationship, and therefore could modify the diffusion process. It would be
`useful to examine whether such effects have actually occurred. and by exten(cid:173)
`sion, how effective is direct-to-consumer marketing in the antiulcer market-
`place.
`.
`Third, and perhaps most importantly, the findings of this paper suggest mter-
`esting topics in the theory of industrial organization. What i~ the o~ti~al mar(cid:173)
`keting strategy for firms when there are spillo~ers and ~arketm~ ~cttvitles ~av~
`long-lived impacts? What is the correspondmgly optimal pncmg behavw~.
`How does this optimal behavior vary with market structure? How I_s the opti(cid:173)
`mal behavior affected by federal tax provisions that allow the expensmg (rather
`than amortizing) of long-lived marketing investments? What are the implica(cid:173)
`tions for social welfare?
`Obviously, much remains to be done. We believe we have demo~strated
`quite clearly that marketing efforts are very important in und.erstandmg the
`diffusion and economic success of new products. Product quahty and pncmg
`behavior have also been shown to play important roles in-the diffusion process.
`We hope the results of this paper contribute to this and other related research
`projects that enrich our understanding of the economics of new products.
`
`I
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`Page 5 of 5