1. International Society for New Institutional Economics
Vertical Integration Trends in the Bulgarian Pharmaceutical Sector: A Case Study
Tamara Todorova Department of Economics American University in Bulgaria
International Society for New Institutional Economics
Iceland, June 2007
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

2. 1. Literature Review: Empirical Studies
Monteverde and Teece (1982)
Masten (1984)
Lilien (1979)
Anderson and Schmittlein (1984)
Anderson (1985)
John and Weitz (1988)
Muris, Scheffman and Spiller (1992)
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

3. 2. Conceptual Framework Asset specificity * site specificity
* physical asset specificity
* human asset specificity
* dedicated assets
* brand name capital
Uncertainty and bounded rationality
Opportunism
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

4. Table 1. Choice of market versus firm contracting
Asset Specificity
Low
High
Opportunism
Market
Firm
Table 1. Choice of market versus firm contracting
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

5. 4. The Bulgarian Pharmaceutical Sector
Consumer preferences
Profitability and nature of distribution
Types of pharmacy chains
Major drug manufacturers
- Actavis
- Sopharma
- Chaika Pharma
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

6. 4. The Bulgarian Pharmaceutical Sector
Legal regulations
EU requirements
Violations of good commercial practices
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

7. Drug Manufacturer
Wholesaler
Retailing
Sopharma
Sopharma Trading
Yes, through Sanita Franchise
Actavis
Hygia
No, attempted through Mareshki Pharmacies
Chaika Pharma
Commercial League
Yes, through Exemplary Pharmacies and Pharmatel, attempted Sofia Pharmacies
Table 2. Vertically integrated structures in the Bulgarian pharmaceutical sector
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

8. 5. Vertical Integration Drives
High transaction costs for drug manufacturers
Low consumer trust – fake or banned drugs
High degree of opportunism on the part of distributors
Quality problems
Long distribution channels
Asset specificity
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

9. Asset specificity favors own production
Asset specificity favors own production. The more specific the drug and the greater the investment in brand name, the greater the likelihood of internalization.
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

10. Branded drugs are expected to be sold predominantly through integrated (own) outlets, while generic drugs through non-integrated outlets.
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

11. 6. Potential for Empirical Research
= profit margin (unit profit) of the
th drug;
= 1 if branded drug, 0 if generic;
= unit costs of producing the
th drug.
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

12. profit is likely to be higher with branded drugs, greater profitability of own production with higher asset specificity.
higher costs are expected to reduce profit; combined effect of production and transaction costs.
an interaction term coefficient that leads to a slope dummy; profits would also fall if branded drugs incur higher costs.
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

13. profit margin falls with sales.
= sales of the th drug
profit margin falls with sales.
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

14. Table 3. Contingency table
generic drug
specific drug
non-integrated sales
(independent retailers)
vertical integration
(own pharmacies)
Table 3. Contingency table
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

15. advertising spent on the th drug
1 if the pharmaceutical manufacturer is vertically integrated with a pharmacy,
0 otherwise;
1 if the drug carries the brand name of the manufacturer, 0 if it is generic;
advertising spent on the th drug
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

16. specificity of drugs drives forward integration in the Bulgarian pharmaceutical sector;
higher advertising expenditures represent greater investment in brand-name capital and imply greater tendency for forward integration of drug manufacturers with pharmacies.
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

17. 7. Discussion
High transaction costs drive vertical mergers of drug manufacturers with distributors.
Common ownership guarantees common supply, common advertising, low cost and low prices of medicines.
Firms achieve full control over financial flows and pricing strategies.
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

18. Better advertising, special handling of products.
Forward integration is important for products that need coordination of marketing and distribution.
Better advertising, special handling of products.
Drugs are sophisticated products that require information, special demonstration or proper display.
Greater efficiency and cost savings.
Tamara Todorova, American University in Bulgaria
Iceland, June 2007

19. The major driving force behind vertical mergers between drug manufacturers and distributors seem to be asset specificity of drugs and the sizable transaction costs faced by producers in a low-trust transition economy such as Bulgaria.
Tamara Todorova, American University in Bulgaria
Iceland, June 2007