This case study is a recent history of the pharmaceutical industry based on all of Porter's five forces.

If you would like to try this assessment on your own business then try out our Porter's 5 Forces Assessment In the 1970s and 1980s, the average profit margin (as a percentage of revenues) of the Fortune 500 pharmaceutical companies was two times greater than the median for all industries in the Fortune 500 Each dru introduced between !"#! and !"#$ %made at least &$' million more for its investors( after ta)es( than was needed to pay off the costs to develop it . . . *uch profitability was two to three percenta e points reater than for comparable industries( even after factorin in the risks of new dru development+. ,early two decades later( in !"""( the industry was still a star. The pharmaceutical industry ranked at the top in all three of Fortune ma a-ine+s measures of profitability. return on sales( return on assets and return on e/uity. 0hat made the lobal pharmaceutical industry so profitable for so lon 1 0hy has its profitability remained so stron ( and will the industry remain so attractive1

Threat of entry
For an entrepreneur( hi h barriers to entry make it more difficult to launch a venture. 2ut happily( for those who are somehow able to enter( these same barriers serve to protect their ventures once they have 3oined the party. Thus( while barriers to entry can be considered obstacles for the entrepreneur( they also serve to keep competitors out of the industry. A number of barriers mute the threat of entry into the pharmaceutical industry. These include barriers both financial and intan ible in nature( ran in from hi h fi)ed costs to strin ent intellectual property protection. 4et+s look in some detail at conditions in the pharmaceutical industry in the !"#5s. 6eavy e)penditure on research and development were 7and still are8 re/uired for the arduous processes of dru discovery( development( manufacturin ( and approval throu h the various re ulatory bodies( such as the Food and 9ru Administration 7F9A8 in the :*A and the ;ommittee on *afety of <edicines 7;*<8 in the :=. The process of developin a dru was time>consumin ( e)pensive and precarious. 9urin the !"#5s( it took an avera e of !? years and &!"@ million to brin a dru to market. And the lon and tedious process( which included research and development( clinical trials and overnment approval( did not uarantee favourable results( as more than 55 per cent of all development dollars were spent on products that never reached the market. The sheer si-e of an investment like this( coupled with the reat uncertainty of whether there would be a payoff( was a powerful barrier to deter those who mi ht have entered the industry. Aesearch and development were not the only e)orbitant costs. *ales and marketin costs were also substantial( as pharmaceutical companies spent lar e sums promotin their dru s to hospitals and doctors. To compete effectively a ainst the industry+s leaders( a new company had to spend millions of dollars annually on lar e salesforces and other marketin and promotional activities. *ubstantial as these financial barriers were( they paled in comparison to the protection that overnments placed on intellectual property. ;ompanies enerally won

patents for their new dru s. These patents were issued on either the dru +s chemical structure or its method of manufacturin or synthesis. This hi hly favourable competitive environment( in which dru companies obtained patents to protect them from rivals( meant that competitors were effectively blocked from manufacturin and marketin dru s with the same chemical composition for !B years( which e/uates to between ei ht and !? years once the dru actually ets to market. The result1 In terms of threat of entry( the picture of the pharmaceutical industry in the !"#5s was clear. Entry barriers were e)tremely hi h( resultin in little threat of entry( a very favourable condition for industry incumbents and for new pharmaceutical startups that could find a way to enter.

*upplier power
Pharmaceutical companies were flooded with raw material suppliers an)ious to sell to such a stron and profitable industry. In !"#?( there were over !?(555 chemical companies in the :*A alone. Their products had lon shelf lives( were readily available from numerous sources( and were bou ht lar ely on the basis of price and delivery. These conditions left the chemical suppliers with little power to set the terms and conditions under which their raw chemicals were sold to the dru companies. From the dru companies+ point of view( supplier power was virtually none)istent.

2uyer power
6ow would you like to be in an industry where your buyers are uninformed about your product and almost !55 per cent insensitive to its price1 ,ot only that( but ima ine that there are few if any substitutes for your product( and that usin it may be a matter of life or death for your consumer. These were( for the most part( the circumstances prevailin in the pharmaceutical industry throu h the !"#5s. The industry en3oyed an almost powerless roup of buyers. 9ru companies reaped the benefits of unaware doctors who were partial to prescribin brand>name dru s to obtain the most medically effective solution( re ardless of priceC price>insensitive patients who did not care about the cost of their prescription medicationsC illinformed consumers who blindly trusted their doctors+ treatment su estionsC and few alternatives to prescription dru s. The weakness in buyer power contributed si nificantly to the profitability of the pharmaceutical companies. These companies also benefited from consumer trends in Europe and ,orth America towards health and nutrition. ;onsumers were increasin ly ea er to do whatever it took to become or stay healthy. Further( consumers had the lu)ury of bein indifferent to dru prices because most of them did not pay full price for their medications. Aather( throu h the !"#5s in most developed countries( overnment a encies( insurance companies or employers paid the patient+s prescription dru bill. And without easy access to information on medications( customers had little say in their treatment plans.

Threat of substitutes
:ntil the mid>!"#5s( the lobal pharmaceutical industry was lar ely unthreatened by substitute products. If a patient was ill( they took the medicine the doctor ordered. Patent laws prohibited companies from replicatin others+ brand>name dru s for as lon as !B years( and other re ulations deterred the development of chemically e/uivalent eneric dru s. For most conditions treatable by prescription dru s( there simply were no substitutes for the medications the doctor prescribed.

;ompetitive rivalry
The pharmaceutical industry of the !"#5s was populated by hundreds of companies( thou h none had more than 5 per cent market share. There were two main reasons the pharmaceutical industry was so fra mented. 9ifferent companies focused on entirely different classes of dru s. These classes included cardiovascular treatments( antibiotics( central nervous system therapy( astrointestinal treatments( etc. The industry+s rowth rate made it easy for competitors to row without takin share from each other. There was little pressure to e)pand beyond one+s niche( iven abundant opportunities for rowth therein. The result of this fra mentation was that most firms had few direct competitors. The lack of direct competition allowed dru companies to raise prices as they pleased. ;ouple this lack of competition with a weak threat from substitutes and little buyer power( and the industry e)perienced little dissent when raisin prices to meet profit ob3ectives. ;ompetitive rivalry was almost none)istent.

*ummary of industry attractiveness

The result of these industry conditions was impressive profit rowth throu h the middle of the !"#5s. 0ith si nificant barriers to entry( docile suppliers( powerless buyers( almost no threat of substitutes( and little rivalry( the pharmaceutical industry in the !"#5s was 3ust about as perfect an industry as one could ima ine. Diven its attractiveness( the industry attracted the attention of enetic and molecular biolo y scientists and the venture capital community( who saw its appeal and thou ht their revolutionary approaches to dru therapy could attract enou h money to overcome the formidable entry barriers the industry en3oyed. Thus( as scientific advances in biotechnolo y took hold( numerous entrepreneurial companies like Denentech and Am en were founded to commerciali-e new scientific breakthrou hs. Denentech( the first biotech firm havin commercial success( developed a protein that broke up blood clots. Am en+s famous molecular biolo y used recombinant 9,A to produce erythropoietin( a hormone that increases the supply of red blood cells in anaemic patients under treatment for cancer and other diseases. 2y

?555( erythropoietin was eneratin &? billion in sales and another &$ billion in licensin revenue for Am en. 2oth of these new entrants fared very well in this attractive industry. Denentech went public in !"#5( and by ?55! its shares had appreciated ?B55 per cent since its IPE. Am en shares( first offered in !"#$( soared more than !'(555 per cent. 0as the pharmaceutical industry an attractive industry in which to play1 The venture capitalists that backed Denentech( Am en and other companies like them have not been disappointed. The scientists>turned>entrepreneurs whose technolo ies were backed have prospered as well. Thus( for entrepreneurs who can marshal the resources to overcome hi h barriers to entry F and who have somethin to sell that customers want F attractive industries like pharmaceuticals can be rewardin places to play( indeed.

The pharmaceutical industry at the turn of the twenty> first century

Alas for the dru makers( industries are not static places. 4ike the rest of the business world( industries are dynamic( sub3ect to ever>chan in environments. The pharmaceutical industry has not remained /uite as cushy as it once was. 4et+s look at what has chan ed.

Threat of entry
*tartin in the mid>!"#5s( the barriers to enter the pharmaceutical industry be an to show cracks. ,ew le islation made it easier for eneric dru companies to enter the market. In the :*A( the !"#@ 0a)man>6atch Act( which chan ed the rules for eneric dru manufacturers( reduced the barriers to eneric entry. Instead of havin to prove the eneric dru +s safety and efficacy( the act re/uired companies only to prove their formulas were e/uivalent to that of the brandname dru . The subse/uent rowth in eneric dru s was profound. 2y !""'( eneric dru s accounted for more than @5 per cent of pharmaceutical prescriptions. Aside from the influ) of enerics( the pharmaceutical companies also saw a wave of biotechnolo y competitors enter their industry F Denentech( Am en and many others F su estin that economies of scale meant less than they used to( and that barriers to entry( while still hi h in absolute terms( were droppin ( thanks in part to the availability of venture capital. Further( the biotech companies+ new science>focused research model( known as rational dru desi n( stood the traditional approach to dru discovery on its head. These dru companies worked backwards from known disease biochemistry to identify or desi n chemical %keys+ to fit the biochemical %locks+ of that disease.

The result of these chan es1 2arriers to entry crept lower( increasin the threat of entry and makin the industry somewhat less attractive.

2uyer power
2e innin in the mid>!"#5s( three developments radually be an to increase the power of the pharmaceutical industry+s buyers. The rowin stren th of mana ed care in the :*A( the industry+s lar est market. Increased pressure from overnments( especially in Europe. A better>informed patient population. The American transition from an insurance>based healthcare system to one of mana ed care chan ed the dynamics of the pharmaceutical industry dramatically. 2y !""$( #5 per cent of the :* population was covered by mana ed care or ani-ations 7<;E8( compared with 5 per cent of the :* population covered in !"#5. These <;Es typically provided full covera e for prescription dru s. 2ut( because of their sheer mass( these institutions had considerable bar ainin power with dru companies( and e)erted stron downward pressure on dru prices. Thus( while patients maintained their price insensitivity for dru s( their healthcare providers were far more price> sensitive. To further increase dru >price awareness in the American medical community( health maintenance or ani-ations 76<E8 set up formularies 7lists comparin the prices and benefits of various dru s8. 6<Es assessed these formularies( decidin which dru s to endorse. If the 6<Es did not approve a certain dru ( then doctors affiliated with the 6<E could not prescribe it. Ef course( it is not surprisin that 6<Es favoured the less e)pensive eneric dru s over brand>name dru s. In !""5( a <edical <arketin G <edia article claimed. %Pharmaceuticals appear headed for commodity status( pushed by enerics( formularies( and other cost pressures+. The American 6<Es were not the only ones puttin downward pressure on dru pricin . European overnments established price controls( limitin prices at which prescription dru s could be sold. In the :=( a new overnment a ency( the ,ational Institute for ;linical E)cellence 7,I;E8( was established to determine the cost>effectiveness of dru s before the ,ational 6ealth *ervice 7,6*8 would pay for them. Finally( by the turn of the century( the comin of a e of the Internet enerated appro)imately !55(555 health>related websites. Powered with more information( patients became more knowled eable and( conse/uently( more powerful. And( with new le islation that now permitted prescription dru advertisin in the :*A( patients there be an takin a more active and knowled eable role in their medical decision> makin . 2uyer power had increased considerably. The result of this increase in buyer power was downward price pressure on prescription dru s.

Threat of substitutes

,ot only was direct competition from eneric dru s impactin the industry( but trends toward more natural therapies led consumers to try substitutes for prescription dru s. E)ercise( nutrition and herbal remedies all be an to take market share from the prescription dru makers.

;ompetitive rivalry
Throu hout the late !"#5s and the early !""5s( rivalry in the pharmaceutical industry increased. Diven the new pressures described above( traditional dru companies felt the pressure to consolidate to take advanta e of economies of scale. 2y choosin to mer e( rivalry amon the top firms increased( as their areas of e)pertise be an to overlap. Additional rivalry stemmed from the flood of more science>focused dru discovery firms. 0hile some biotechs were purchased by the lar e dru companies( others became stron competitors in their own ri ht. :nlike the dru companies( biotechs were not burdened with hi h overheads( and they possessed superior product and disease knowled e in their chosen se ments. Aational dru desi n enabled them to discover new therapeutic compounds more /uickly and more efficiently than before. 0hile traditionally these biotechs had discovered new dru s and then sold their discoveries to established dru companies( this pattern seemed to be chan in ( as some be an not only to discover but also to develop and market their own dru s. Thus( the pharmaceutical industry found itself with a whole new set of competitors( some of which had lower cost structures and were more a ile and science>focused. ;ompetitive rivalry had increased.

*ummary of industry attractiveness twentyfirst century

enterin

the

6ow has the industry fared in li ht of these developments1 A study by the :* ;on ressional 2ud et Effice concluded that( %since !"#@( the e)pected returns from marketin a new dru have declined by about !? per cent( or &?B million in !""5 dollars. That decline has probably not made dru development unprofitable on avera e( but it may have made some specific pro3ects unprofitable+. In spite of its decline in attractiveness( in ?555 the pharmaceutical industry still ranked as the most profitable industry in the :*A. Aeturn on assets was !B.B per cent. The top !! :* pharmaceutical companies enerated almost &?55 billion in revenues that year and profits of &?# billion. 0hile not /uite as attractive a place to compete as it had been in the !"#5s( the pharmaceutical industry remained far more attractive than most. 0hy1

Threat of entry remained comparatively low( despite the incursion of eneric dru makers and biotech firms. *tartin a pharmaceutical company isn+t nearly so simple as( say( startin a restaurant. 2uyer power had increased F a enuine problem. 2ut suppliers to the pharmaceutical industry still lacked power. *ubstitutes such as e)ercise( nutrition and herbal medicines were no match for prescription therapies for cancer and other life>threatenin illnesses. ;ompetitive rivalry remained modest( as the dru companies( havin common interests( sou ht to protect their traditionally hi h profit mar ins. Thus( the pharmaceutical industry remained an attractive place to play( far more so than most industries( includin the di ital subscriber line industry( which we e)amine ne)t. 0ill this continue to be the case( or will the pressure of these trends erode the industry+s attractiveness further1 Enly time will tell.

4essons learned from the pharmaceutical industry

As the pharmaceutical industry e)ample shows( re ulatory issues can have powerful effects on industry attractiveness and the profitability of the firms that comprise it. 0here re ulation makes it difficult for competitors to enter and compete( and other forces are also favourable( it+s worth an entrepreneur+s trouble to find a way in( as the biotech companies have done. 2oth the lon >established players and the biotech newcomers have prospered. The pharmaceutical industry e)ample also shows that hi h barriers to entry are ood. 4ove and cherish them. And( once you et in( work to keep the barriers hi h. The same is true of weak buyer and supplier power( and of little threat of substitutes( as we+ve seen here. Even si nificant chan es in some of these forces were insufficient to detract si nificantly from the dru industry+s overall performance. Finally( entrepreneurs should note that industry performance data( like those cited in this chapter for pharmaceutical industry performance( are readily available in business libraries in most developed economies. It+s well worth a look at such data in the early sta es of assessin an opportunity. If an industry is a poor performer overall( you should take a critical look at your opportunity to ask why it should fare differently. 0ithout a persuasively positive answer to this /uestion( I would su est movin on to somethin more attractive.