Product competition, managerial discretion, and manufacturing recalls in the U.S. pharmaceutical industry

• Author: Kaitlin D. Wowak,George P. Ball,Rachna Shah
• Date: 01 March 2018
• Published date: 01 March 2018
• DOI: http://doi.org/10.1016/j.jom.2018.04.003

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Journal of Operations Management

journal homepage: www.elsevier.com/locate/jom

Product competition, managerial discretion, and manufacturing recalls in

the U.S. pharmaceutical industry

George P. Ball

a,∗

, Rachna Shah

b

, Kaitlin D. Wowak

c

a

Operations and Decision Technologies Department, Kelley School of Business, Indiana University, 1309 E. 10th Street, Bloomington, IN 47405, United States

b

Supply Chain and Operations Department, Carlson School of Management, University of Minnesota, 321 Nineteenth Avenue South, Minneapolis, MN 55455-0438,

United States

c

Department of Information Technology, Analytics, and Operations, University of Notre Dame, 326 Mendoza College of Business, Notre Dame, IN 46556, United States

ARTICLE INFO

Accepted by: Tyson Browning

Keywords:

Product competition

Product recall

Quality failure

Managerial discretion

ABSTRACT

Empirical research examining whether and how competition influences product recalls is limited. We address

this important research gap by creating a novel measure of product competition using data from the Food and

Drug Administration's Orange Book, and combining it with product recall data across a 12-year period. Our

results show that product competition is positively associated with manufacturing-related recalls, providing

evidence of a possible downside to competition in the pharmaceutical industry. Although competition is fostered

by numerous federal regulations, we find that it may encourage companies to relax quality standards during the

manufacturing process, which may result in lower quality products. We also find that this relationship is con-

tingent on managerial discretion surrounding the recall decision. While product competition is associated with

an increase in high severity, low discretion recalls, it is associated with a decrease in low severity, high discretion

recalls. Findings from this study have critical implications for policy-makers who regulate product competition

in the pharmaceutical industry.

1. Introduction

A fundamental principle of capitalism rests on the widely held no-

tion that competition is predominately good, resulting in lower prices

and higher quality (Friedman, 2009;Mazzeo, 2003). Economic theory,

however, suggests a more nuanced view. While competition typically

leads to lower prices, the relationship between competition and quality

often depends on whether the price is regulated or set by firms (Gaynor,

2006). When the price is regulated, the competition-quality relation-

ship is clear: competition improves quality (Gaynor and Town, 2011;

Gaynor, 2006). However, in settings where prices are set by firms, the

impact on quality is not as clear (Matsa, 2011;Gaynor, 2006;Jin,

2005). Kamien and Vincent (1991) as well as Ma and Burgess (1993),

for instance, showed that if prices are set by firms, increased compe-

tition results in lower quality while Allard et al. (2005) and Dranove

and Satterthwaite (1992) found the opposite result. Additionally,

policy-makers in certain industries have leveraged regulations to in-

crease competition with the goal of lowering prices for consumers, but

the effect of such regulations on product quality remains uncertain.

The Drug Price Competition and Patent Term Restoration Act of

1984 is a prime example of such competition-inducing regulation.

Commonly called the Hatch-Waxman Act, this legislation was intended

to increase product competition in the pharmaceutical industry and

lower drug prices by creating an expedited approval process for generic

drugs. Before this Act, every drug went through a long and an expensive

New Drug Application (NDA) process that required extensive clinical

tests and trials. This Act introduced a second, expedited drug approval

process: the Abbreviated New Drug Application (ANDA) process. The

ANDA process only requires firms to demonstrate evidence of a drug's

bioequivalence (comparable in “dosage form, strength, route of ad-

ministration, quality, performance characteristics, and intended use”-

FDA, 2017a) to an original, pioneer drug rather than conduct lengthy

clinical tests and trials themselves. In other words, a drug is eligible for

ANDA approval if there is an original version of the drug already on the

market to which it can be compared.

The ANDA process was designed to spur product competition in the

pharmaceutical industry by making lower priced drugs available to

consumers, while still maintaining high product quality standards. As

intended, the ANDA process has led to a considerable increase of

bioequivalent drugs entering the market and in reduced drug prices

(FDA, 2015). Because drugs approved via the ANDA process need to be

bioequivalent to pioneer drugs, firms are not allowed to change the

https://doi.org/10.1016/j.jom.2018.04.003

Received 4 August 2016; Received in revised form 23 April 2018; Accepted 25 April 2018

∗

Corresponding author.

E-mail addresses: gpball@indiana.edu (G.P. Ball), shahx024@umn.edu (R. Shah), Katie.wowak@nd.edu (K.D. Wowak).

Journal of Operations Management 58–59 (2018) 59–72

Available online 30 May 2018

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