The Market for High-Quality Medicine:Retail Chain Entry and Drug Quality in India

Dan Bennett, University of ChicagoWesley Yin, UCLA and NBER

RAND CorporationMay 18, 2015

Motivation

Heterogeneous and uncertain drug quality• Counterfeits and substandard drugs pervasive in dev. countries• Small producers manufacture generic drugs with little oversight

Health and economic impacts• Inadequate treatment, toxicities, drug resistance• Effective medicine and human capital accumulation, labor supply,

earnings (Miguel and Kremer 2004, Baird et al. 2012).

Motivation

Link between growth and provision of drug quality• How does income growth translate to provision of quality?

Role of income growth• Normal good, consumers demand higher-quality medicine• Production of high quality medicine exhibits scale economies;

growth pays for organizational changes • Allows for stronger legal institutions/tort law enforcement, fosters

higher product quality (Spence 1977, Landes and Posner 1987)• How do private markets improve quality in the face of imperfect

information and weak regulation?

This Study

Chain store pharmacy forms, enters Indian retail market• (High quality) chain’s formation is a response to increased demand• It’s entry punctuates equilibria in local markets

Demand growth and organizational change• Quality improvements driven by technological and organizational changes (new

systems of distribution, vertical integration, large investments in QC , etc.) • As demand markets grow, larger firms can exploit scale economies. • Firms that can produce higher quality have incentives to jointly produce and

signal quality (Milgrom & Roberts 1986)• Chains may have stronger incentive to invest in and signal quality (Akerlof 1970;

Jin & Leslie 2009)

Effects on incumbents is ambiguous• Competition on price/quality vs. market segmentation

Study Design

Natural experiment design• MedPlus is a new pharmacy chain with integrated distribution,

contract manufacturing, ostensibly high quality, lower prices• In 2010, chain execs identified 18 candidate markets in

Hyderabad to enter• Appropriate retail space opened up in 7 of 18 candidate markets• Plausibly exogeneous entry• Survey all markets (+2) before/after entry (5 stores per market)• Data collection: “secret shopper" pharmacy audit, consumer

survey, pharmacy survey, customer traffic enumeration

Summary of Findings

Main results• Incumbents lose customers, some exit the market.• Quality at incumbents improves; prices fall (especially for non-national brands)• Both high-SES and low-SES consumers/markets benefit• Consumers imperfectly perceive quality improvements• Incumbents match the chain's quality but not its prices, revealing productivity

differences

Mechanisms• Retail competition with price and quality elastic consumers• Chain entry raises awareness of quality, shifts preferences• Reject wholesale market spillovers, whereby chain entry reduces stocking of

low quality drugs among wholesalers

Outline

• Background• Study design and empirical strategy• Main results on price and quality• Interpretation

Background on Indian drug market

Manufacturers• 250 “national" manufacturers and around 8000 small “local" manufacturers• Limited regulatory oversight, particularly for local manufacturers

The supply chain• Mom-and-pop pharmacies buy from a complicated supply chain

Retailers• Market power• Have more discretion over price/quality for non-national brands• Through longstanding relationships with wholesalers, retailers appear to

develop perceptions of quality

Retail Pharmacies in Hyderabad

Incumbents• Small single-enterprise “mom and pop" pharmacies compete locally on price

and quality.• Study markets have a median of 24 pharmacies/km2• The median pharmacy occupies 350 square feet of space.• 13% of incumbents have air conditioning and 15% have a door.

Chain pharmacies• Three chains operate in Hyderabad: MedPlus, Apollo, and Hetero.• MedPlus founded in 2008 and operates around 250 stores in Hyderabad.• MedPlus pharmacies are enclosed and air conditioned• MedPlus contracts with manufacturers to produce/sell in-house brand• MedPlus bypasses wholesale market; buys direct from national brands

Got amoxicillin?

Background on drug quality

Determinants of drug quality• Quality control during the manufacturing process.• Proper handling and storage during distribution and while on shelf.• Procuring ingredients is not a major quality constraint

Indian Pharmacopeia standard• Active ingredient concentration, uniformity, and dissolution.• A sample is substandard if it fails in any dimension.• In our data, most substandard samples fail the active ingredient requirement.

Surveyed drugs• Ciprofloxacin and amoxicillin are two important, widely-used antibiotics• The effectiveness of antibiotics is difficult to infer

Outline

• Background• Study design and empirical strategy• Main results on price and quality• Interpretation

Study Design

Logistics• In 2010, the chain identified 18 candidate entry markets• We added 2 slightly lower income markets• Based on our pharmacy census, we enrolled 5 pharmacies per

market (n = 100) in the study.• After a baseline survey, the chain actually entered 7 markets.

Natural experiment• MedPlus entered markets where it could obtain suitable space.• Suitable retail space opening plausible exogenous• Contextual, statistics evidence support validity of study design

Data Collection

Components• Pharmacy census (n = 401).• Mystery shopper audit with quality testing: samples of ciprofloxacin

and amoxicillin collected by high-SES and low-SES auditors (n = 800)• Consumer survey with shoppers and non-shoppers (n = 5234)• Pharmacy survey and customer traffic enumeration (n = 107)

Timing• Round 1: May-July 2010• Round 2: May-July 2011• Round 3: May-July 2012 (census, traffic, consumer)

Comparing Chain to Incumbents

Empirical Strategy

Model

• Audit scenario s, pharmacy i, market m, time t• Market fixed effects• Time varying market demographic and health characteristics• Cameron, Gelbach, and Miller (2008) bootstrapped SE’s

Identification• Factors that determine entry are uncorrelated with unobserved time-varying

factors that affect the outcome (e.g. demand growth)• Exogeneity supported by contextual, statistical evidence, and tests for

unobserved selection

Identification

Candidate markets limited to middle income markets• 250 stores in Hyderabad, relatively wealthier areas• Final expansion to a few middle income markets; did not consider

slightly less affluent neighborhoods• 18 markets chosen on basis of income; relatively more homogenous,

limiting potential for selection into treatment on unobserved SES

Entry depending on vagaries of thin real estate market• The chain had very specific space requirements and a short window

for final expansion in Hyderabad• 1000-1200 ft2 on ground level facing busy commercial street• Spaces too small are large turned down

No differential trends

Ex-post validation

Effect sizes large relative to variation in key SES variables• Market average income would need to more than double in

treatment markets to generate treatment effects• Education levels would need to increase by 5 years (50%)

Bounds on selection on unobservables• Follow Oster (2014) and Altonji et al. (2005) to bound extent of

unobservable selection needed to generate effects spuriously• Under assumption of proportional selection, unobserved selection

would have to be implausibly large

Chains have subsequently entered 9 control markets.

Outline

• Background• Study design and empirical strategy• Main results on price and quality• Interpretation

Secular quality trend

Climate• Humidity and temperature are key determinants of quality,

especially for these antibiotics.• Water molecules necessary for molecular breakdown; heat

increases the rate of chemical reaction• Peak relative humidity was 8.7 points higher in Round 2 than in

Round 1.• The share of audit days with both high temperature and humidity

rose from 54 percent in Round 1 to 97 percent in Round 2

Impact on Quality

Impact on Quality

Impact on Prices

Robustness checks

Outline

• Background• Study design and empirical strategy• Main results on price and quality• Interpretation

Effects not due to spillovers

Consumer preferences

The Market-wide Impact

Motivation• Both chain entry and the incumbent response matter for consumer

welfare.• The benefit of chain entry may vary across consumers

Socioeconomic heterogeneity• Across pharmacies: interact with average customer education.• Within pharmacies: interact with mystery shopper SES.

Modifications to the previous approach• Include observations from the chain in the regressions (+7 pharmacies).• Weight the regressions by the customer traffic

Productivity of the Chain

Market-wide impact

Is Quality Observable

Consumer Information• Competition only leads to higher quality if quality is observable.• Quality may be indirectly observable through advertising, reputation,

and word of mouth.

Actual and Perceived Quality• The impact of chain entry on perceived quality.

Methodology• Our consumer survey elicits perceived quality on a scale of 1-4.• The perceptions of non-shoppers are easier to interpret because of

selection into the shopper sample.

Consumer perceptions

Conclusion

Implications• Chain entry has positive quality externality for non-chain consumers.• Consumers appear to infer quality through imperfect market signals• Productive organizational technologies (e.g. chains) with scale economies and

their competitive effects » On quality and prices of incumbents» Driving out less productive firms » Joint mechanism translating income growth to higher quality

• Perhaps long run, single-enterprise shops exit, market will rely on competition among chains

Policy• In settings without an effective quality regulator, policymakers may improve

drug quality by encouraging chain retailers