Pfizer the Cost Structure for

Pfizer The cost structure for the development of pharmaceutical products is very high. Viagra received FDA approval in 1998, and the average level for drug development costs between 1995 and 2000 was $1.16 billion. This cost includes not only the cost of developing the drug, but also obtaining the patent and obtaining FDA approval. The latter process typically takes several years and requires successive stage of clinical trials.

For a major pharmaceutical company like Pfizer, the development cost of a marketable product like Viagra must also include development costs associated with products that do not make it to market. Only an estimated one in six drugs that reach the clinical trials stage are finally approved for marketing. The economics of the pharmaceutical industry dictate that successful products must be priced in such a way that not only allows them to cover their own development costs, but the costs of failed products as well (Outsourcing Pharma, 2003).

As a result of these economics, the industry tends to favor development of only blockbuster drugs, defined as those with estimated sales in excess of $1 billion. Viagra would certainly be classed as a blockbuster drug. It has sold over $1 billion for the past several years. In fiscal 2009, Viagra sales for Pfizer were $1.892 billion, down 2.1% from the previous year. Most of this decline was attributable to the impact of unfavorable foreign exchange movements, thus, the impact of translation risk rather than a true decline in revenue (Pfizer Financial Report, 2009).

Because of the emphasis on recovering development costs and funding new development, Pfizer has high gross margins on products that make it to market. In fiscal 2009, the cost of goods sold for the company was 17.8% of revenues, a gross margin of 82.2%. Research and development costs accounted for a further 15.7% of revenues (Ibid). The relationship that can be implied from the economics of the pharmaceutical business is that firms will attempt to maximize revenues from blockbuster products such as Viagra.

These products receive patent protection, creating an effective monopoly, which allows for this profit maximization. The cost of producing the good is therefore largely irrelevant to the price at which it is sold. The other considerations weight more heavily. There are likely some cost savings due to economies of scale, although that would be difficult to test for in a product such as Viagra, which has enjoyed strong sales its entire existence, and for which specific production cost data is unavailable.

With respect to Viagra, Pfizer is operating in a constant returns to scale environment. The market for Viagra has been slow growing in recent years, and at a high level. The changes in demand for Viagra are of such small size that they are unlikely to have a significant impact on production costs. The primary impact of economies of scale is with respect to the manner in which drug companies exploit the high margins they can earn on blockbuster drugs to finance their operations.

Even with this, the contribution that these drugs make is based less on the ability of the company to control production costs by building economies of scale than it is on the company's patent protections which allow them to exploit low price elasticity of demand. Economies of scope are more significant for the pharmaceutical industry. A product such as Viagra is used to.