Porter's Five Forces Analysis of Pharma Sector

Porter’s Five Forces Analysis of Pharmaceutical Industry
The pharmaceutical industry develops, produces, and markets drugs or pharmaceuticals licensed for use as
medications. Pharmaceutical companies are allowed to deal in generic or brand medications and medical devices.
They are subject to a variety of laws and regulations regarding the patenting, testing and ensuring safety and
efficacy and marketing of drugs. The pharmaceutical industry is one of the fastest-growing economic sectors with
worldwide sales of more than $982 billion in 2018. Approximately 47% of sales each year come from the U.S., with
sales at $464 billion in 2018. Pharma is a dynamic industry with rapid growth and the potential for high profits. Top-
selling drugs have annual sales in the billions. However, a new drug requires millions of dollars invested in research
and development (R&D) and testing before it can be brought to market. The majority of new projects never receive
approval from the FDA, resulting in large amounts of capital burned just to get one profitable product. Individual
pharma stock investors face a difficult task in analysis due to the high level of technical expertise required to
adequately evaluate the viability of potential new products, as well as the continued prospects for existing FDA-
approved drugs. The most stable stocks are those of large- and mega-cap companies with multiple products and
large R&D budgets. However, the greatest returns come from smaller companies that achieve scientific
breakthroughs.
Coined by Michael Porter, a Professor of Strategy at Harvard Business School; he stated that a company’s
profitability in an industry is determined by five-industry level forces. They are:
 Bargaining Power of Buyers: This broadly refers to the extent buyers are able to put pressure on the
company, which is broadly a factor of the customer’s ability to react to price changes. In Pharma industry patient
(consumer) has an absolute lack of power regarding pricing. The consumer has no choice but to buy the
medications as prescribed by the doctor. The only entities with the negotiation power are the pharmacies and
medical institutions, they have moderate amount of power as there are many companies providing similar
products. As these entities buy in bulk quantities and can exert pressure on pharma companies to keep prices in
check. So, we can say that bargaining power of buyers is a medium competitive force.
 Bargaining Power of Suppliers: This broadly refers to the extent suppliers are able to put pressure on
the company, when charging for the raw materials or products that they give to it. The suppliers have little power
in the pharmaceutical industry. The raw material required for manufacturing drugs are commodity products in the
chemical industry, which are available from numerous resources. There are number of chemical suppliers present
in the market. So, instead of buying chemicals at high cost, pharma companies can switch from one company to
other. As we know, the cost of switching from one supplier to another, for that particular raw material, determines
the bargaining power of that supplier, so in pharmaceutical industry, where the switching cost is low, the
bargaining power of the supplier is also low.
 Rivalry among Existing Competitors: As the factor suggests, an industry with high rivalry among existing
competitors is one which is characterized by consistent price wars, high degrees of innovation, increased marketing
attempts and service improvements. The degree of rivalry among pharmaceutical companies is very high. This
occurs among competitors because one or more of them either feels the pressure or sees the opportunity to
improve their position in the market place . It can be intense if companies are scrambling for market share, but if
the overall market is in growth or the position of the company is protected through patents, then the rivalry are
likely to be less intense, but now-a-days even strong non-disclosure and non-compete clauses cannot prevent the
leaking of competitive information. Due to increasing demand of high-quality drugs, low-to-moderate entry barrier
to the new entrant, the presence of a number of large and small firms makes this market highly competitive.
 Threat of Substitutes Products: A substitute product nearly performs the same function as the
industry’s product and service but by different means. For pharmaceutical industry, the threat of substitute ranges
from moderate to high. The demand for generic drugs compared to branded drug has increased because of cost. As
we know, generic manufacturers do not incur the high cost involved in research and development and regulatory
activities such as FDA approval and clinical trials. So once a drug loses its patents, generic drug manufacturers start
selling copycat versions at substantially lower prices. A drug that netted $100 million a year in profit could become
one that earns only $1 million a year in profit overnight. Additionally, there is a major international problem with
counterfeit drugs. The best of these counterfeits duplicate a real drug's formula and sell it at a lower price, which
hurts corporate profits. The worst counterfeits are made with low-grade materials and can destroy the reputations
of legitimate products. These are the reasons; why they can offer their product at cheaper price. This increases the
threat of substitutes.
 Threat of New Entrants: As the factor indicates, it refers to an industry where the barriers to entry are
low. The threat of new entrant is low to moderate based on the following factors: It has become very important for
the pharmaceutical companies to focus on research and development to sustain their position in market. The cost
associated with research and development is very high. Also, there are the stringent government regulations for
approval of new drugs which act as high barrier. Besides this, various other challenges such as drawing up
appropriate distribution strategies, selecting the right products, anticipating competition among others are limiting
the entry of new barrier in market. Many pharmaceutical companies are progressing in the market by shifting from
traditional business approach to emerging new business approach. The new business technique includes contract
research (drug discovery and clinical trials), contract manufacturing and co-marketing alliance. Many new
companies wants to enter the market without burden of costly tasks such as research and development, clinical
trials and manufacturing of drugs. Moreover, patent expiry is one of the reasons which are offering opportunities
for lower cost generic manufacturer in terms of greater market access. Additionally, the government has increased
their focus on healthcare cost cutting. It is creating pressure on the authority to allow early introduction of low-cost
drugs in the market. This, in turn, poses a big opportunity for pharmaceutical companies with approved facility and
sound knowledge of regulatory issues. Therefore, all these factors are responsible for the high threat from a new
entrant.

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