Roche Corporation Is a Global

Roche Corporation is a global developer and marketer of medicines and diagnostic equipment to the health care industry. Based on Switzerland, Roche operates around the world, with the revenue emphasis on developed markets. The company has three main lines of business -- pharmaceuticals, diagnostics and products for researchers. The company is therefore subject to a variety of demand influencers in its many different markets. Health care is one of the most highly regulated industries in the world, and the vastly different systems create different supply and demand dynamics to which Roche must adapt. This paper will analyze the dynamics that affect Roche and the company's reactions to those dynamics. Although Roche breaks down their world scope into six unique geographies, the emphasis for this discussion will be on their major markets of the U.S. And Western Europe.

The Health Care Industry

Health care is one of the world's largest industries. In the United States alone, the health care business will be worth an estimated $2.6 trillion in 2010 (Minter, 2010), representing around 16% of the country's total GDP (Financial Forecast Center, 2010). Figures for the size of the industry are similar in other countries, if perhaps slightly lower (the U.S. has the world's highest level of per capita health care spending). Costs in the industry are focused on drugs, care costs, research and infrastructure costs.

There are a number of demand drivers in the health care industry overall. A major influencer of demand is the payment structure. In most Western nations, health care is covered through some form of government insurance scheme. In the United States, the government covers a sizeable portion of health care through Medicare and Medicaid; the rest is covered through private insurance or cash payment. The different payment systems can impact demand on certain products, in particular pharmaceuticals. Many government-sponsored plans, for example, favor generic drugs when available whereas private insurance companies favor name brand drugs as they simply mark the product up and pass that cost along in the form of premiums. As a result, the demand drivers for the U.S. And for countries with public health care are different with respect to the ability of pharmaceutical companies to market high margin branded drugs over lower-margin generics. Some governments also cap the amount that they will pay for drugs, reducing the dollar value of the demand for drugs in those countries.

Another key factor in the demand for health care is the age of the population. This is a significant factor in most major Western markets today because populations throughout the developed world are aging rapidly. The United States, Canada and Australia in particular experienced massive baby booms in the 1950s, and that cohort today is entering its senior years. This has caused a surge in demand for health care in these countries, and in other Western nations to the extent that they experienced a baby boom of their own. Demand for health care is projected to expand in the Western world significantly over the course of the next 30-40 years as the baby boom cohort passes through its senior years (Hennessey, 2009). The number of Americans 65 and over is expected to increase by 36% in the next ten years alone (Aker, 2008), resulting in the creation of 3.2 million new jobs. Ten of the top twenty fastest-growing corporations are in the health care industry (Bureau of Labor Statistics, 2010). Demographics will be the major driver of demand in health care for the foreseeable future.

Where demographics and government policy intersect in the U.S. is that citizens over the age of 65 are entitled to benefits under Medicare. This entitlement program is covered by the American taxpayer. The demographic shift will put an increasing number of citizens on the Medicare program while an increasingly smaller percentage of the population is in the workforce to foot the bill. The result will be strong pressure on politicians to address the issue. The current health care reform process is the first step in addressing this issue. While an aging population indicates increased aggregate demand for medical services, the dollar value of that demand may be subject to a variety of caps if the U.S. federal government finds that medical spending is impacting its other ventures or if the country's deficit begins to spiral out of control.

Another key demand driver for health care is the relative healthiness of a population. Healthiness affects demand in two key ways. As health improves, people need less medical care, particularly during their younger years. In general, the health care industry benefits from an unhealthy population. However, as health care improves, people live longer. This in general increases health care demand over time, because the percentage of the population that is elderly increases. In most of the Western World, the general trend is towards healthier populations, as reflected in rates of diseases and in increasing life expectancies. In the U.S., life expectancies are still increasing, albeit slowly. Perhaps of more significance is that younger generations are faced with more health problems that were their parents. Obesity rates have ballooned, so to speak, and the result is that rates of diabetes and other weight-related illnesses have increased in the past several years in the United States. This has contributed to the overall increase in the demand for medical care.

Roche Corporation

Pharmaceuticals make up 79% of Roche's revenues. There are specific drivers to this industry. One of particular interest in terms of microeconomics is the incidence of disease. Roche saw Tamiflu sales increase to 3.2 billion Swiss francs in 2009, a direct function of fears surrounding the H1N1 virus outbreak. These sales accounted for 6.5% of the company's total revenue. Tamiflu sales in 2008, by contrast, were around 1 billion francs (2009 Roche Corporation Annual Report).

Overall, technological development has a strong impact on the demand for products in the pharmaceutical and diagnostic fields. When new medicines receive their approval from the relevant government agencies, and these medicines represent an improvement over existing treatments, the result is a spike in revenues for the firm. This is especially true where the new drug offers dramatically superior performance to generics or treats conditions untreated by generics. In such a situation, the sales spike would also include the socialized medicine countries, not just the United States. Roche's pharmaceutical division, for example, saw its sales growth spurred by ophthalmology drug Lucentis and a slate of improved cancer drugs.

For many drug products, marketing is a key demand driver. Pharmaceutical companies often find themselves in direct competition, with little to differentiate the competing products in terms of performance, or with products so vastly different in function but roughly the same in terms of impact. In such situations, marketing becomes a key demand driver. Drug companies aim their marketing at three distinct markets. The first are the physicians. It is doctors who ultimately must prescribe the drugs, so convincing each doctor to prescribe your company's drug is key to generating sales demand.

The second group to whom pharmaceutical companies aim their marketing is the consumer market. Consumers can enquire with their doctors about specific drugs and can create demand for drugs if they have a greater awareness of those drugs. As a result, recent years have seen an influx of pharmaceutical marketing aimed at consumers. The third group to whom the pharmaceutical industry markets is the insurance industry. Insurance companies must cover drugs under their plans, as a large segment of the health care system is financed by the insurance companies. Without their support, a drug will have very little demand.

For a company like Roche, demand is driven in a number of ways. Three key decisions result in a sale- the decision of the insurance company to cover a product, the decision of the patient to request a product and the decision of the doctor to prescribe it. While demographic, competitive and regulatory factors contribute to aggregate demand, ultimately these three choices will result in demand for any specific product, along with the product's attributes and the effect of any public health situation.

Demand factors in diagnostics are similar, but without the consumer element. The microeconomics of demand for diagnostic products is focused on the physicians. For any given diagnostic, there may be a number of different techniques. As a result of this, information marketing is directed by diagnostics companies at both the physician level and the wholesale level. With the consumer element removed, the emphasis becomes much more on performance of the tests and equipment. Demand is driven as much by the quality of the product as by the intensity of the marketing effort. Doctors and purchasing departments at health care institutions are both involved in the demand process. Diagnostic equipment is also subject heavily to the factors in the macroenvironment -- demographics and the healthiness of the population especially.

Elasticity of Demand

There are a number of ways in which these broad drivers of health care manifest. The first is with regards to elasticity of demand. The complex nature of payment for health care services is reflected in the variety of drivers impacting elasticity. It has been found that in general, the elasticity of demand for health care is -0.17, meaning that for a $1 increase in the cost of health care there is a decline in demand of $0.17 (Ringel et al., 2005). Health care is a unique product. It would be reasonable to think that the cost of one's health is irrelevant -- that consumers would place nearly infinite value on their health, resulting in very little elasticity of demand. Indeed, a figure of -0.17 indicates that this is true to a significant extent. Demand for health care does not drop precipitously when health care costs increase. In the United States, however, it does drop. There are several ways in which consumers reduce their health care expenditures in the wake of increased prices. They may switch from branded drugs to generics; they may reduce their level of care; or they may seek lower cost solutions.

Insurance must also be taken into consideration with respect to the elasticity of demand. An individual given unlimited funding would be apt to believe his or her health to be sacrosanct, and therefore the elasticity of demand would be zero. However, when economic decisions are required, some sacrifices may be made. When the body making the decision is not the patient, the elasticity should be expected to increase. Indeed, for an insurance company, there is direct economic incentive to reduce service in the face of rising costs. Insurance companies either place a cap on funding or find ways to eliminate coverage. In either case, the reduction in demand that results from an increase in cost has less to do with the consumer's lack of desire to pay so much as a combination of the insurance company's lack of desire and the patient's lack of ability.

Insurance companies gain their revenue from the premiums that they collect. The company then disburses this money as claims. By reducing the amount of claims paid or the number of claims paid, insurance companies can increase their profits. In the face of rising costs, the propensity to reduce coverage is economically justifiable. This does, however, place limits on demand growth for pharmaceutical and diagnostic companies like Roche.

Governments represent another major customer for health care. Elasticity of demand with government services has been steadily increasing over time. The current U.S. health care debate effectively centers on the issue of cost control as much as any other issue. Provincial health care plans in Canada are also seeing pressure to contain costs. There are two different proposed responses. One is to cut access to certain forms of health care or certain drugs. Forcing consumers to cover these costs out-of-pocket or through insurance will compel some of them to reduce their treatment, stop it altogether, or find ways to reduce the cost of the treatment. Each of these actions will have the net effect of reducing demand. For a company like Roche this can have a wide range of impacts. Consumers may opt for generics to save money, even at the expense of effectiveness. Consumers may also be willing to try alternative medicines such as traditional Chinese medicine in order to reduce their health care costs.

The other way, such as is proposed in the U.S. health care reform, is that governments will seek to increase their bargaining power. Canada's government already exerts strong bargaining power over pharmaceutical companies resulting in lower drug prices; the same in the U.S. would lead to dramatically reduced per capita demand in health care. For a firm like Roche, this may be offset by the demographic trends but eventually lower per capita health care expenditures will affect the company's profits.

Rising health care costs threaten to increase the historic elasticity of demand for health care. For Roche, this has strong strategic implications. In the short run, Roche can leverage the low elasticity to gain profit but in the long run governments will have a strong mandate to reduce health care costs. This will in turn reduce per capita demand. Roche will need to find ways to counter this trend in order to maintain its share and its profit margins.

The possibility of substitutes, such as homeopathics, TCM and other forms of health care, raises implications for Roche with respect to cross-price elasticities of demand. At present, there is only a small degree of cross-price elasticity in health care. Demand for alternative medicines is growing, but the field remains a niche market. This demand is driven partly by the high cost of scientific health care but also in part based on philosophy -- some consumers simply prefer not to make extensive use of the scientific health system. Should the price of health care -- pharmaceutical in particular -- increase too much, however -- which it does when insurance companies drop coverage and governments refuse to pay for certain drugs or treatments -- then the demand for alternative medicine increases. As governments and insurance companies seek to curtail health costs in the face of dramatically rising demand, they will an increasing amount of health care costs on consumers. To the point where this suppresses demand for Roche's products and stifles growth opportunities, it may increase demand for alternatives. At this point and going forward, however, there is little evidence that the trend flows other way. Roche does not see significant change in its demand on the basis of price changes in alternative medicines, primarily because the effectiveness of such treatments is not high enough to justify a mass scale consumer switch. Should that change, cross price elasticities between scientific medicine and alternative medicine would increase, adding a new dynamic to Roche's microeconomic environment.

The Supply Side

Roche, as with most other firms in its industry, has a high degree of pricing power over its suppliers. Roche is a global company with revenues in excess of $46 billion. While most of their suppliers are relatively large companies and high end labor, Roche's sheer size gives it the ability to control prices. This is reflected in the consistency of the company's gross margin over time. In 2009 the gross margin was 29.7%, compared with 31.6% in 2006 (MSN Moneycentral, 2010).

The traditional drivers of supply pricing are the demand, the availability of supplies and the bargaining power of the respective parties. Despite the high degree of bargaining power for pharmaceutical and diagnostics companies and their low degree of backward integration, they have little difficulty finding suppliers. In part, this is because firms such as Roche can take advantage of the relatively low elasticity of demand to pass costs along to consumers.

One interesting dynamic of Roche's supply side is going to be in future when governments in particular seek to curtail spending on health care. From Roche's perspective, demand will almost assuredly increase regardless as a result of the dramatic demographic shift. However, on a per capita and on a per item basis, there is little doubt that Roche and other drug firms will be squeezed. Governments already use their bargaining power to placed downward pressures on prices, and the goal of health care reform is in part to increase the U.S. government's buying power so that it can place downward pressure on costs as well. So despite the overall increase in aggregate demand, for any individual product, Roche will be facing downward price pressure over the coming years and decades.

For Roche, this will probably impact on the supply side. Roche will need to exert its bargaining power more in order to pass those cost reductions along to its suppliers. That the company is so large will give it an advantage in doing this. The suppliers will likely be forced to be price takers, due to Roche's sheer size. There is essentially no risk that suppliers will exit the industry if they are faced with lower prices for their goods, since they will still be in a large, high-growth industry, and this is to Roche's benefit. Suppliers committed to the industry have higher exit costs, which means that it will be easier for Roche to drive down its costs using its economies of scale on these firms, knowing that there is little to no risk of losing supply. Roche's supply side considerations are far less critical to the course of its business in the coming years than are its demand side considerations.