Pharmaceutical companies face infamously high barriers to entry in the United States. Many economics and business textbooks cite the pharmaceuticals and drug sector as examples when describing barriers to entry. Most countries have some barriers to the entry of the legal drug sector due to the research and manufacturing startup costs, but the U.S. Food and Drug Administration (FDA) and significant health care regulations make the U.S. a special case.

Key Takeaways

  • A barrier to entry is an obstacle that restricts or impedes a company's efforts to enter an industry.
  • Pharmaceutical companies in the United States face enormous barriers to entry, including difficulties in achieving Food and Drug Administration (FDA) approval, high research and development (R&D) costs, and intellectual property challenges.
  • Recent studies estimate it costs on average $2.8 billion for a pharmaceutical company to bring a new drug to market and the process can take up to 10 years.

Common Hurdles to Drug Production and Manufacturing

Economies of scale play an important role in industries where producers manufacture large quantities of small products, such as with pharmaceuticals. It may initially be difficult for a new company to attempt to produce the same drug as a larger, established drug firm. This is because the larger firm already has a large infrastructure and distribution network established and has achieved better marginal economies.

The natural road to competition in the drug sector is through product differentiation and marketing. However, brand name recognition is critical when dealing with supplements or drugs that can have physiological effects. Most consumers are rightly wary of a product they have never heard of or a company they do not trust. This can be a difficult barrier to overcome. The industry also faces normal manufacturing barriers including high startup costs, time to build and maintain functioning capital equipment, and uncertain legal liabilities.

Additional Barriers to Entry

Food and Drug Administration (FDA) Approval

Before any company can make and market even a generic pharmaceutical drug in the United States, it must be granted a special authorization by the FDA. The time required for a pharmaceutical company to achieve approval on Abbreviated New Drug Applications, or ANDAs, is hardly abbreviated. In its "Activities Report of the Generic Drugs Program," the FDA reported a median approval time of about 27 months for the third quarter of 2019.

In an August 2019 report, the Government Accountability Office (GAO) found that only 12% of the 2,030 generic drug applications reviewed by the FDA from fiscal years 2015 through 2017 were approved in the first review cycle.

For pharmaceutical companies looking for approval on a new drug, each application is incredibly political and even more expensive. In the meantime, established pharmaceutical companies can replicate the product awaiting review and then file a special 180-day market exclusivity patent, which essentially steals the product and creates a temporary monopoly.

Research and Development (R&D) Costs

The Tufts Center for the Study of Drug Development estimated the average cost of bringing a new drug to market with post-approval research and development (R&D) costs was $2.8 billion. Other reports estimate costs could be as high as $11 billion to $12 billion, depending on the drug being developed. A single clinical trial could cost as much as $100 million, and the FDA usually approves about one in 10 clinically tested drugs. Just as significantly, it can take up to 10 years for a drug to be approved for prescription. Even if a startup company had the $2.8 billion to develop and test the drug according to FDA rules, it still might not receive revenue for 10 years.

Intellectual Property Challenges

Intellectual property hurdles are substantial for two reasons. First, patents are often taken out to use as legal weapons by huge companies to fight off their competitors even if they do not plan on completing trials for the drug. Second, legitimate patents are risky because they might run out, and often do, before the FDA approves the prescription, essentially creating a patent cliff from the get-go.