The effect of generic competition on prescription to over-the-counter switching

Objective: While it is generally accepted that the decision to switch a dru g from the prescription market to the over-the-counter (OTC) market is base d on an optimisation problem that firms are solving, no attempts have been made to formalise the problem. The purpose of this article is to present a model of prescription to OTC switching that helps explain the role of poten tial generic competition in a firm's decision to switch. In particular, we examine what market conditions are necessary for the threat of generic comp etition to induce switching. Design and setting: The model is game-theoretic, played between an incumben t firm and a potential generic entrant, and is solved for its subgame perfe ct equilibrium. The incumbent first decides whether to apply to the FDA to switch to the OTC market. If the incumbent declines, then the potential gen eric entrant has the opportunity to apply for the switch. The FDA then acce pts or rejects the application, and the generic chooses whether to enter th e market. Results: In equilibrium, when applying to switch is costless, switching occ urs if the probability that the application will be approved by the FDA is strictly positive and the OTC market is characterised by first-mover advant ages. Adding a cost to the application process places restrictions on the p robability of FDA approval to offset the cost of applying. The probability of approval must be sufficiently high to offset the cost of the application . Conclusions: The model shows that. switching from the prescription to OTC m arket may occur as a response to potential generic competition. Firms switc h because they know that if they do not, a generic may initiate a switch an d become the first mover in the OTC market.