The Successful Launch and Diffusion of New Therapies - Innovation and Marketing in the Pharmaceutical Industry - page 202

7.2 Step 2: Extracting the Potential of a New Treatment

In assessing the potential of a new treatment, pharmaceutical companies gain insight
into the types of decisions they need to make to extract value from the new treat-
ment. Marketers have studied two main methods of extracting the commercial
potential of a new treatment: setting the price of the new treatment and increasing
unit sales through promotional expenditures.
Many studies (e.g., Kremer et al. 2008 ; Mizik and Jacobson 2004 ; Stremersch
et al. 2013 ; Venkataraman and Stremersch 2007 ) have looked at the effect of promo-
tional expenditures (e.g., DTCA, direct-to-physician advertising, detailing) on
demand for pharmaceutical drugs, obtaining mixed results. Pricing strategies of new
treatments have been studied to a lesser extent (e.g., Berndt 2000 ; Ekelund and
Persson 2003 ; Lu and Comanor 1998 ). Researchers have also shown increasing
interest in the threat of generic substitution and its consequences for the pricing of
drugs (Frank and Salkever 1997 ; Hariharan et al. 2013 ).
Pharmaceutical companies' decisions regarding drug price levels and promo-
tional expenditures, which are crucial for extracting value from the commercial
potential of a new treatment, are often a source of controversy in the pharmaceutical
industry. In the following subsections we discuss each of these two types of
decisions.

7.2.1 Pricing New Treatments to Maximize Profits

Pharmaceutical companies' pricing decisions with regard to new treatments are
often cause for debate. Opponents of current price levels claim that the prices of new
drugs are too high given the low marginal cost of producing them. Hence, they con-
clude that high price levels of new drugs only serve companies' profit motives
(Berndt 2000 ). However, pharmaceutical companies state that these prices are justi-
fied given the high research and development (R&D) costs and the high risk involved
in the development of a new drug (Lu and Comanor 1998 ). Furthermore, industry
executives claim that in many international markets, drug prices are no longer suffi-
cient to reward companies for taking these high risks. Indeed, sufficiently high price
levels are necessary to guarantee a society's access to innovative life saving drugs in
the future (Santerre and Vernon 2005 ). Economists support this claim by showing
that innovation is threatened by low price levels (DiMasi et al. 2003 ). Notably, how-
ever, pricing decisions have been found not to depend exclusively on past R&D
expenses (Verniers et al. 2011 ; Vernon et al. 2006 ; Wagner and McCarthy 2004 ).
Lu and Comanor ( 1998 ) examined drivers of launch prices of new drugs relative
to the average prices of existing brand-name substitutes (in the same categories) in
the USA over the period 1978-1987. Unsurprisingly, they found that drugs with a
larger therapeutic potential were priced higher than drugs that constituted smaller
therapeutic advancements. Furthermore, a higher number of branded substitutes