The question of whether advertising acts as a barrier to entry has been a subject of ongoing controversy in the industrial organization literature. Advertising might disseminate information, thereby increasing market size, and help consumers make rational choices. On the other hand, advertising might merely persuade consumers of product differentiation where none exists. The second type of advertising could act as a barrier to entry. Such a barrier to entry might be profitable to construct if the incumbent has a long period of legal monopoly with a specific date when entry is permitted, as a patented product does in the pharmaceutical industry. Previous work on entry deterrence in the pharmaceutical industry has included advertising to physicians as an explanatory variable in a generic firm’s entry decision. However, the brand’s advertising choice is endogenous in this context, because both advertising before patent expiration and generic entry depend on expected profits in the post-entry period; and hence, both advertising and entry will be affected by the same forces and the same random errors. This paper analyzes the entry decision more carefully by instrumenting for endogenous, pre-expiration, brand advertising. I conclude that brand advertising is not a barrier to entry by generic firms.
When a pharmaceutical patent expires, generic firms may enter that market and begin selling an exact replica of the original drug. The entry decisions made by many generic firms determine the observed outcome in any given market. Each potential entrant examines the characteristics of the available markets, including those affected by brand behavior such as advertising. The entry decision is based on expectedprofits, which themselves depend on market characteristics, brand advertising, and the potential entrant's expectations of other generic firms' behavior. For a given revenue stream, a brand producer benefits from fewer generic entrants. The availability of strategies that may be effective in deterring entry is an important issue for producers of branded pharmaceutical products.
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Barriers to Entry, Brand Advertising, and Generic Entry in the U.S. Pharmaceutical Industry
