The effects of medical insurance and patients’ preference on manufacturer encroachment in a pharmaceutical supply chain

Abstract

With the development of e-commerce, manufacturers have opportunities to sell products to consumers through direct channels in addition to independent retailers. Although manufacturers’ encroachment upon the retailing market of traditional goods has been extensively studied, there is a lack of research on manufacturers’ encroachment in a pharmaceutical supply chain. This paper analyzes a pharmaceutical manufacturer encroachment strategy by taking into account the distinctive features of drugs, in which drug expenses are covered by medical insurance only in the physical channel and patients' channel preference is also considered. We find that under certain circumstances, the manufacturer encroachment may lead to a win-win outcome for both the manufacturer and the retailer, contradicting the conventional wisdom that the manufacturer's encroachment into retail space is detrimental to the independent retailer. Additionally, the manufacturer is more likely to encroach when the incurred extra cost is sufficiently small, the perceived quality of the drug selling through the direct channel is sufficiently high and the out-of-pocket percentage cost of the drug selling in the physical channel is high. We further study the impact of manufacturer encroachment on social welfare and find that the introduction of encroachment decreases the social welfare when patients' perceived quality of the drug obtained through the online store is low and improves the social welfare when the perceived quality exceeds a certain threshold.